HONG KONG — As they prepare for the end of quotas on Jan. 1 — an event that most people in the apparel industry expect to be a boon for China — executives here are wondering just how the historic event will play out for them.
“It’s very strange that we’ve got the biggest seismic event in our industry and no one knows what’s going to happen,” said Steve Feniger, chief executive officer of Linmark, a sourcing firm that caters to about 30 customers and has links to 1,000 factories in China that make soft and hard goods.
Most concerns among Hong Kong’s big sourcing firms focus on the issue of safeguard quotas. China joined the World Trade Organization in 2001, more than halfway through the phaseout period. In response to diplomatic pressures, China agreed to a measure called safeguard quotas, which would allow other nations to put limits on Chinese imports, in particular categories where “market disruption” occurs. The safeguards can be imposed for one year at a time and renewed for up to three years.
With jobs and the economy playing a major role in the U.S. presidential election, executives in Hong Kong and China are concerned the U.S. might move quickly to impose limits on China, particularly if its shipments surge in early 2005.
The nations of the WTO agreed to phase out quotas over a 10-year period, and some categories have already been freed of restrictions. In January 2002, several categories of goods, including bras, knit fabrics and robes, were liberalized. However, after total exports from China surged some 400 percent, in December 2003 the Bush administration imposed safeguard quotas limiting exports to no more than 7 percent higher than the previous year’s shipments in those three categories of Chinese goods.
Nonetheless, over the long term, manufacturers are confident the new trade rules will bring growth opportunities.
“We see that the graduation from the quota era is going to offer new opportunities for those that believe they can compete in a world arena,” said Andrew Leung, managing director of Sun Hong Knitting Factory Ltd. and chairman of the Textile Council of Hong Kong. “China has huge potential to grow, because historically [it’s] been limited.”
To tap into that potential, Sun Hong Knitting Factory, which employs 3,000 people in Hong Kong and China, has invested $2.5 million in China this year for machinery, software and factories.
“We see that as an opportunity for us to capture a bigger share of the market,” Leung said.
The investments are geared to post-2005 as a way to protect market share. For now, the company, which has high-end clients such as Sonia Rykiel, plans to hold tight for the first few months of the new year to monitor the reaction of the market and also see what competitors are doing.
Sun Hong Knitting exports about 25 percent of its products to the U.S., 60 percent to Europe and the remainder to Asia and other places, Leung said. He said having operations in Hong Kong and mainland China offers a balanced mix, but other firms have gone farther afield to ensure diversity.
Linmark now sources 45 percent of its products in “Greater China,” which includes China, Hong Kong and Macau; 25 percent on the Indian subcontinent, including India, Bangladesh, Pakistan and Sri Lanka; about 23 percent from Southeast Asia, and the remaining 7 percent from Africa.
The sourcing company is taking advantage of prices coming down in Southeast Asian countries as those nations try to fight back against China. Still, Feniger suggested that in two to three years these countries will be fighting to retain their business.
By 2009, Linmark expects 70 percent of its sourcing to be done in China, with the balance on the Indian subcontinent, which boasts embroidery and other craft skills, as well as a strong raw materials base.
In immediate preparation for the lifting of quotas, Linmark has closed offices in Singapore and Manila; the closings were “very much driven by quota elimination,” Feniger said. The company has in turn opened sourcing offices in China in places such as Fuzhou, Dongguan and Qingdao.
Over the past 18 months, the sourcing firm has developed three risk strategies for its customers: high, medium and low.
The high-risk strategy identified China as the place to be after 2009, while hoping that everything will be OK in 2005. The medium bracket suggested sourcing items that won’t be affected by antisurge mechanisms in China and moving the “hot” quota items, such as pants and T-shirts, to other locations in Southeast Asia. The lowest-risk strategy was for customers to leave their supply networks unchanged and not rush into China.
Linmark advised its clients not to put all their eggs in one basket. They all opted for the medium-risk strategy.
Fountain Set (Holdings) Ltd., a leading knitter, is taking a similar approach. The company has four factories: three in China and one in Sri Lanka, which it plans to hold on to for the near future.
“The advantage of Sri Lanka will continue,” said Gordon Yen, Fountain Set executive director.
Some of those advantages include a proactive government keen to develop and preserve the textile industry there; the country’s location, which allows it to serve the European market fairly efficiently, and easier-to-handle local logistics because Sri Lanka is such a small island, Yen said.
Fountain Set’s third factory in China was a recent addition in 2003. Prior to setting it up, the company looked offshore, but it felt confident in expanding in China with the country’s ascension to the WTO, Yen said.
At manufacturing giant Luen Thai Holdings Ltd., the company’s backup plan involves an “outward processing arrangement” allowing final production to be done at two facilities in Hong Kong and Macau, China’s special administrative regions. About 500 workers will work at those plants when they are fully operational.
Henry Tan, ceo at Luen Thai, said the Hong Kong facility is in the process of being renovated and is expected to be ready in January. That facility will run no matter what, while Macau is more of a backup.
The company is also building a 323,000-square-foot factory in China and is expecting to hire 3,500 employees. The factory should be able to produce 18 million garments a year when fully functional, Tan said.
Luen Thai’s annual revenues top $500 million. The firm has 20,000 employees globally and a client list that includes Polo Ralph Lauren and Liz Claiborne. U.S. clients account for 70 to 80 percent of its portfolio. The company manufactures in Cambodia, China, the Philippines and the U.S. territory of Saipan.
For small to midsize companies, such as Moregoal Industries Ltd., the game plan is similar, but the consequences of a misstep could be more devastating.
David Chan, director of Moregoal, said family-owned firms like his need to be more conservative in their investments.
The company now has two factories in China, with the biggest employing 1,300 people. It’s also invested in machinery for a factory in Thailand that will be run by a partner there. In Hong Kong, Moregoal has a knitting factory with 120 machines, plus a smaller plant with 30 part-time workers to do finishing work; it can handle 800 pieces at a time. This plant is Chan’s backup, to be used in emergencies.
“I’m just following the footsteps of what the big brother is doing,” he said.
Chan said he invested heavily in computer machinery, but has pulled back further investments until he sees what the future holds. His rationale for the investments is that 80 percent of Hong Kong factories have computerized knitting machines, as opposed to hand-worked machines.
Chan said he sees two long-term paths for Moregoal: It can either grow by accumulating more factories or become smaller and more specialized. At the moment, 40 percent of the company’s clients are in the U.S., 40 percent in Europe and 20 percent in Australia.
While many Chinese manufacturers are wondering what effect safeguards could have on them, Top Form International Ltd. already has direct experience.
Willie Fung, chairman of Top Form, said additional safeguard initiatives won’t hurt the company much. If Top Form isn’t able to ship all its production because of lack of quotas, he still expects to be able to ship about 90 percent of it, he said.
But he’s “concerned, because it’s the community you live in,” he said. “What happens in one category can affect the other.”
Top Form has production at three locations in China, which account for about 55 percent of its output. It also has four factories in Thailand, accounting for 38 percent of output, and one in the Philippines generating about 7 percent of its output.
Fung said the company’s goal is to “maintain a balance in China production and off-China production.”
The company has started operations in its new factory just north of Bangkok. It is a “testing the water approach,” but Fung hopes the facility will “approach mature capacity in April.”
Top Form has also expanded its workforce in Jianxi Province in China, which is something it planned to do four or five years ago, “despite quota uncertainty in general.”
The manufacturer sends 78 percent of its bras to the U.S., with the remainder going to Europe, Asia, New Zealand and Australia. The company is also considering expanding production to other innerwear products, but won’t make a move until things have settled, which Fung anticipates will be in 2006.
Top Form has grown by double-digit percentages consistently over the past few years, and Fung said he believes the company will still expand next year, but in single digits. The company’s annual revenue exceeds $150 million. He added that the brassiere industry’s quota situation is “crystallized,” but the entire industry is stuck in limbo, so he’s not sure whether his product will get caught in the crossfire.
“China clearly wants to be a major economic power in the region,” he said, but the country realizes it “has to leave something on the table for emerging economies.”
While China’s apparel industry faces significant hurdles, including power shortages, flooding and problems with social compliance, it’s still seen as a dominant player.
“Garment manufacturing will move to China eventually…whether it’s ’05 or ’08,” said Tan from Luen Thai. He added the advantages of China include a stable government, a mobile and effective work force, fabric and trim suppliers, and a reasonably good infrastructure.
“It’s a dream for manufacturers,” he said.
Infrastructure in China, especially South China, is in place, which yields efficiency at an optimal price, said Leung from Sun Hong. He added that Hong Kong is “still an ideal place to manufacture high-quality, good designs.”
While they’re confident in China’s competitive position, executives acknowledged that the potential for safeguard restrictions leaves many open questions.
Linmark’s Feniger said of the looming change: “It’s going to be very disruptive and very exciting.”