Appeared In
Special Issue
WWD Sourcing Horizons issue 03/18/2008

John Cheh, vice chairman and chief executive officer of Esquel Group, opened his presentation by explaining the difficulty of the task presented to him: how a company like Esquel combats the rising costs of energy and raw materials.

This story first appeared in the March 18, 2008 issue of WWD. Subscribe Today.

“I tried to convince the organizers to let me use a different topic called ‘Passing on Cost Increases,'” joked Cheh. “Somehow they wouldn’t let me.”

The strains facing suppliers like Esquel have become an increasing subject of discussion among sourcing executives, and most in the industry have been bracing themselves to pay more for their goods this year. As one of the world’s largest producers of cotton shirts, with facilities in China, Malaysia, Vietnam, Mauritius and Sri Lanka, Esquel has a large exposure to economic pressures. But Cheh isn’t sounding the alarms about price increases quite as loudly as perhaps some of his smaller competitors might.

The gradual inflation of China’s currency, the…yuan, is one aspect that Cheh believes is a certainty.

“The [yuan] is a one-way bet,” said Cheh. “It will only go up. The only question is by how much and how fast.”

Cheh pointed out that currency valuations of other Asian countries have risen more than the yuan, however. In the case of Vietnam, the government strictly controls currency valuations in order to maintain the country’s appeal as a low-cost manufacturing destination. Further complicating the matter has been the decline in the value of the dollar.

The increased cost of labor is another issue that has garnered significant attention. A new labor contract that raised minimum wages in China was implemented at the beginning of the year and average wages are expected to expand 15 percent or more each year in the near future. Despite this, Cheh believes the focus on the issue of wages may have been overblown.

“In my view, the new labor contract law is not an issue,” he said. “It’s only an issue for companies or factories that weren’t complying.”

The Chinese government has also raised rates for social insurance payment. Cheh said in his discussion with local Chinese officials he mentioned how those costs could significantly impact the business. The response from government officials, said Cheh, was to question why the company would honestly report the number of workers it employed.

The policy changes by the Chinese government are being made with the thought of moving the country’s manufacturing sector into production of higher-end products.

“When you move upscale, there is at least more room to absorb some of these pressures because the margins tend to be better,” he said.

Foreign investors will likely also face higher taxes as the government moves to implement a unified corporate tax rate. These are necessary steps, said Cheh, as China looks to continue fueling growth while quickly evolving. The situation is not favorable for most Chinese companies, with one out of six companies in the country losing money. This is in large part due to excess capacity. Cheh said only the top 9 percent of companies are returning a 5 percent profit margin.

“It’s a tough environment, and it’s going to get tougher still,” he said. “What that means is really a period of consolidation, but that matches what sourcing directors and brands and retailers are already doing.”

Solutions for suppliers will center on ways to improve productivity and gain efficiency. Esquel spent $500,000 on new energy-efficient lightbulbs for its factories, a cost it expects to recoup within 15 months. The company is also constantly looking at ways to reduce waste, standardize materials and start moving toward higher-end products.