By  on September 27, 2005

HONG KONG — There are two key factors to avoiding a safeguard quota-related migraine in the sourcing business here: Shuffle manufacturing sites and diversify business.

Some Hong Kong sourcing firms have complained bitterly about goods stuck at European Union ports or garments being held at factories in China because they can't ship to the U.S. because of the sudden imposition of quotas. Others anticipated what might happen and came up with backup plans well before quotas were dropped in January and then reinstated as safeguard measures by the U.S. and EU later in the year.

Linmark's strategy for E.U.-bound garments was to relocate production of sensitive categories, such as cotton shirts and trousers, out of China to Thailand and Vietnam.

It was in some ways easier but more mysterious dealing with U.S.-bound goods.

"It never occurred to us there would be clear and easy access," said Steve Feniger, chief executive officer of Linmark.

As a result, Linmark just planned on not getting sensitive categories through.

"We were pretty accurate and planned accordingly" on the U.S. side, he said.

But for the EU, the sudden cap was "a surprise" because of the speed of what happened. The EU struck a deal with China, after threatening to impose safeguard quotas limiting annual growth on specific categories to 7.5 percent, that imposed growth caps on 10 textile and apparel categories in June. The deal allowed for graduated growth from 8 percent to 12.5 percent for those 10 categories through the end of 2007.

While hailed as a breakthrough when it was signed, the deal backfired when shipments logjammed at EU customs because some quota categories were already filled, sometimes literally while goods were on boats sailing to port. In addition, retailers were left coping with a shortage of garments for the coming season.

"The European community was caught with their pants down," with no goods for Christmas, said Michael Mankoff, general manager of sourcing firm Lark Apparel Holdings.

A quick-fix deal was reached this month between the EU and China, so that the more than 58 million trousers and 75 million sweaters stuck at customs or in transit could be released.While Hong Kong-based Lark still has a sizable presence in China, it also shifted production of sensitive categories to places such as Bangladesh and India, Mankoff said.

Lark, which has 90 employees in eight offices worldwide, also has outward processing arrangements in southern China, he added. This allows the company to have sweater panels made in Taiwan, for example, and then shipped to China for finishing and washing. With this arrangement, the sweater would still be considered made in Taiwan.

It does require more paperwork, time and freight costs, however, Mankoff noted.

For clients who enquire about producing sensitive categories in China, Mankoff said he gives them three prices: OPAs in southern China, manufacture completely outside of China or manufacture in China and deliver in January. Lark hasn't taken any China business in the second half this year for sensitive categories.

Lark's business is split 70 percent with U.S. clients and 30 percent with EU clients, although a 50-50 split would be preferred, he said.

It still does 50 percent of its manufacturing in China for nonsensitive goods with the remaining 50 percent throughout the region. In 2008, Mankoff anticipates Lark will shift 90 percent of its business to China.

"You have to look at this every year," he said. "Everyone's not just sitting and waiting to see what happens with China."

William E. Connor & Assoc. isn't a company that is sitting around and waiting. Even if there aren't safeguards in 2008, there will be other trade issues, including antidumping measures, said Mark Hayden, regional director of North Asia for the privately held firm.

Connor, which has about 1,400 staff in 35 offices in 20 countries, forged a back-up plan that consisted of using China factories that could switch to using OPAs in Hong Kong or Macau if safeguard quotas were slapped on, as they were. Hong Kong and Macau are special administrative districts of China and their exports are treated separately.

For Connor, "less than 50 percent would be China country of origin," Hayden said. "We've intentionally recommended to clients not to go into China in a big way."About 30 percent of its garments are made in China — only nonsensitive categories — and about 50 percent completed in Hong Kong or Macau outward processing facilities. The remaining 20 percent is made in Southeast Asia and the Indian subcontinent, as well as other countries.

Part of Linmark's coping mechanism included a bit of shuffling.

"As we moved EU and U.S. customers out of China, we were moving Canadian, Australian and South African ones in," said Feniger, since those countries had not imposed quotas.

Garment sales to Australia, South Africa and Canada, plus hard goods, now account for as much as 26 percent of shipment volume for 2004-2005 and is valued at $200 million. The company doesn't provide data showing a breakout of hard goods.

Linmark's turnover for the year ended April 30 was $89.8 million. Turnover rose about 266 percent in its first quarter ended July 31 to hit $40.8 million.

The shifting of orders allows the sourcing firm to continue using its manufacturing contacts in China for sensitive categories that are restricted for the U.S. and EU. The model works well because factories in China are nervous about taking orders for the U.S. and EU, Feniger said.

"One person's loss and another person's gain," he added.

Diversification also has been an important backbone to business with the uncertainty in the textile and garment industries.

Connor, which likes to call itself a "boutique buying agent," has a 50-50 split between apparel and home goods, such as furniture and home textiles, Hayden said, adding that the goal this year is $1.6 billion in sales generated from about 60 clients.

On the apparel side, Connor targets moderate to high-end retailers such as Saks Fifth Avenue, Nordstrom and Lands' End. Ten percent of its clients are from the EU, while the U.S. makes up 75 percent and Australia, 5 percent.

While Linmark doesn't break out hard goods from its overall data, Feniger said hard goods plus apparel to Canada, Australia and South Africa and nonsensitive garments for the U.S. and EU account for 46 percent of its production.

Diversification is something Lark is working toward. It doesn't want to rely on agency business only, Mankoff said. To that end, the company has forged a joint venture in Vancouver with The Marquis of London, a women's sportswear manufacturer that specializes in leather and has three brands. The company also is exploring a joint retailing operation in China.Part of the problem with the current trade tension, Feniger said, is that the two sides — China and the U.S. and EU — don't understand each other.

From Beijing's perspective, the "U.S. [has been] espousing free trade for as long as anyone can remember," he said. However, it's free access for the U.S. in China, but not China in the U.S., he added.

"It's not even a level playing field" from China's perspective, Feniger said.

Then the U.S. can't understand how China can have such a great surge in products, he said, adding, "I can understand both positions."

"Hopefully, this is an anomaly for this year," Connor's Hayden said. "If [the U.S. and EU] had phased it out properly, we wouldn't be in this mess today."

Moving forward, there are a lot of concerns and questions. "The big question mark is how they'll allocate quota," Hayden said.

Hong Kong manufacturers have expressed concern that the majority of quota will go to Chinese companies. The method is still under discussion, with options including giving quota based on a manufacturer's performance and auctioning a percentage of quota, which would allow Hong Kong manufacturers to participate.

Some major vendors in China also have canceled factory expansion plans.

Another concern for the future is the revaluation of the yuan. The recent 2 percent increase was absorbed without any concern, Feniger said. However, 5 percent would have an effect, he added.

The Severe Acute Respiratory Syndrome scare that paralyzed business across the region and with the West a couple of years ago is never far from people's minds. Add to that recent pig-related diseases, Avian flu, gas shortages, electricity outages and labor unrest, and you have a system that could be crippled by external forces.

Nevertheless, Feniger said, "China is the future."

Linmark in recent weeks opened an office in Hangzhou and plans to open two more this year. The pace, however, is "decelerated."

It was obvious 11 years ago with the creation of the World Trade Organization that the U.S. was giving up some control of its economy, Lark's Mankoff said. It isn't an ideal situation, he added, because "lobbyists in the U.S. aren't going to let go of the petitions and safeguards," referring to U.S. textile organizations being the driving force behind the Bush administration imposing safeguard quotas."A dying industry is dying a slow death," he said.

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