All through the 2nd half of 2008, hundreds of blog posts and newspaper articles mentioned the closing of numerous factories, most notably in the Guangdong province and in the toy industry. Government statistics seemed to confirm this. But these figures are so unreliable (only about properly-filed bankruptcies) and general (about all exporters mixed together) that I won’t even reproduce them here.
From my observation, the starting point of all these articles was the much-mediated closing of a large toy factory in Dongguan, Guangdong. Most people concluded that costs had gone up too fast, or that orders had dried up. Of course, no one knew exactly what happened, but they wrote that low-margin and low-quality exporters would be wiped out one after the other.
And… FINALLY someone did some research and came back on what happened in this case. In an article entitled “Not playing”, The Economist describes the company, and then explains the process that led Smart Union to liquidation:
Smart Union quickly evolved from making cheap, injection-moulded figurines to toys with mechanical and then electronic parts. Its clients included Mattel, Hasbro and Disney. Within the clubby world of toy manufacturers, […] Smart Union was seen as one of the winners, a trusted manufacturer with none of the quality problems that came to terrify the buyers of Chinese products.
Was it a low-quality producer? Did they have a poor image in the market? Not really. So what killed them?
Even as it apparently enjoyed strong growth, […] problems were emerging. Profits, for example, were dropping, in part because of huge reinvestment to cover the expansion in sales, but also because China began to overheat in 2007. Every manufacturing-input cost rose, from electricity to petroleum (for plastics) to metals to wages. A new, costly, labour law came into effect. And the appreciation of the yuan meant orders priced in dollars—the overwhelming majority—brought in less income. Big global retailers were unsympathetic, showing their own greater knowledge of Chinese manufacturing by driving ever tougher bargains with small producers that desperately needed orders.
All true. And all applicable to Chinese exporters. But is this what forced them to closed down?
None of these factors would have been fatal, but for an abrupt tightening of credit in early 2008 that, in effect, cut Smart Union’s working capital in half. Sources of money that had been plentiful in 2007 dried up. In desperation the firm asked suppliers to be patient and buyers to accelerate payments, and raised costly loans from outside the banking system.
In June severe rain hit Dongguan. There were unconfirmed reports that local officials allowed dams to be opened, out of concern that they might not hold. Whatever the cause, a flood swept the city and Smart Union was badly hit. More than HK$65m in inventory was lost, along with a month of work. Piles of damaged goods still lie outside one of its factories. Rumours of an impending closure caused suppliers to pull back deliveries and workers to demand salaries in advance. “I learnt that without confidence, a business is dead,” says Mr Wu. The firm essentially shut down in September, despite having a heavy backlog of orders.
So much for the rising costs and dropping orders… Three other factors were at work:
- A tightening of credit. Yes, it seems like banks were much more cautious with the crisis… Just like in the West. I also heard about that a few months back. But I didn’t read a single article that mentioned it!! And another interesting thing is that “a heavy backlog of orders” is not enough to convince bankers in China… Local banks don’t give out loans based on business viability here. It’s more about who you know in the local authorities.
- Most foreigners don’t know, but Chinese companies tend to be under-capitalized and to go for growth more than profit (I’ll describe this in another post coming up.) Of course, when banks feel that risks are going up and refuse credits, it’s the end of the party.
- Bad luck also played its part: a flood that ruined inventory and delayed production. But that’s only the proverbial straw on the camel’s back.
I am not expecting any reliable statistics from China’s government (as China is among the least transparent countries in the world), so this type of analysis is very interesting.