A few months ago, Steve Dickinson wrote about what would happen to low-tech factories along the coast of China in Factory Closings In South China. All Part Of The Plan:

Low value added/high labor content manufacturers from Wenzhou in Zhejiang down to Zhuhai in Guangdong are undergoing extreme financial stress. The affected sectors are in the traditional outsourcing industries: textiles, toys, shoes and furniture.

The 12th Five Year plan clearly states that a primary goal is to eliminate low value added/high labor content export manufacturing from the entire coast. The intent is to shift to high value added, technologically advanced manufacturing and modern services in this region.

The main question in my mind is: when will this transition be 50% done?

I think we are only 10-20% through it. In Guangdong (the most mature industrial base in China), there are still tens of thousands of low-tech factories. Most of them are still in business, some of them have disappeared, and new ones are set up every day.

Of course, they are feeling the pressure from rising costs, unfavorable government policies, and the competition from factories with a lower cost base. It means most of them make very little profits, and many of them actually lose money.

But Guangdong still has the highest share of low-tech products. Inspection firms will tell you that the highest number of garments and promo items are still made there.

Note that Guangdong province is not the only one involved in this transition. In Wenzhou (Zhejiang province), a few months ago, I heard many small manufacturers were not making enough cash to reimburse their debts and had to close down.

Why is this transition taking so long in Guangdong?

There are many factors at play:

• A supplier base that buyers have taken years to find and train (and that is not easy to replicate somewhere else).
• A dense network of sub-suppliers that are often in the same area as the assemblers, which means faster production runs and lower minimum quantities.
• A supply chain and a logistical environment that are particularly reliable and efficient.
• A high number of buying offices that were set up locally, and the proximity to Hong Kong (which is still involved in a significant part of Chinese exports).

For more information on this topic, you can read What future for Guangdong manufacturing?.

What are the consequences of this transition?

As Steve Dickinson recently wrote in How YOU Must Prepare For It., importers should be more careful then ever while this transition accelerates:

Many companies will fail. Many of these companies will have a long and excellent track record of performance. But they will still fail because their business model no longer works.

In this environment, there are substantial risks that foreign buyers must prepare for with great care:

• Many buyers pay an advance deposit for products. Many failing manufacturers will collect these deposits with no intention of ever manufacturing the product.
• If a manufacturer is struggling, the level of defects will rise to a shockingly high level. Manufacturers that owe a credit or refund from prior defects will not pay. There is also tremendous pressure for the manufacturer to substitute low quality or non-conforming components to save money. Lead content paint on toys or low quality fasteners on clothing are examples.
• Many buyers pay for their product at the time of shipment without doing an inspection of the product. This leads to a great risk of fraud in dealings with a manufacturer who is going to go out of business in a short time. Some standard frauds are as follows:
• The manufacturer simply does not ship the product. Sometimes the manufacturer will convince the buyer to make a payment to a new bank account. Often this bank account is in the wrong name or even in a different country. When the buyer complains that there has been no shipment, the manufacturer claims the buyer is the victim of fraud by someone other than the manufacturer. We are seeing this one a lot, with the “new” bank account being a personal (rather than a business) one.
• The manufacturer takes payment, and then ships an entirely different product or a non-conforming product. For example, a container of frozen fish will turn out to have one layer of fish and the remainder of the container is bricks. Or a container of a frozen food product when unfrozen will turn out to be entirely rotten product. We had a client receive a shipment of frozen salmon that was so rotten that the container was declared a hazardous waste site right on the dock.
• Even where the buyer inspects, we have recently seen a number of cases of outright fraud. In these cases, the buyer watched the product be loaded and the container sealed. The manufacturer then switched the container on the dock and sent an entirely different product to the buyer.

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Related article: The 3 trends of China manufacturing