China and the Toyota problem

The cost of made-in-China goods is rising. Labour rates are going up. So too is the value of the yuan, China’s greatest subsidy. How will this effect China’s garment exports? Drawing comparisons with car-maker Toyota, which last year made it to the top slot as the world leading automobile producer, David Birnbaum looks at the hubris from the supplier side.

2009 was a good year. It was the year that Toyota reached the number one position as the world’s leading automobile producer. It was also the year when China, at least for the month of September, crossed a magic line to account for over 50% of all garments imported into the United States.

It followed, then, that 2010 would be the year to end all years. It was to be the year that Toyota would take over the global automobile industry and the year that China would take over the global garment export industry.

That 2010 never happened. In its place we have another 2010 – the year that exploded the Toyota/China myth. We all know what happened at Toyota. The China debacle, on the other hand, is only now taking place.

Even now, the raw data still looks good, at least on the surface, with the first four months registering all-time records. Perhaps April 2010 was not as good as one would have hoped, but April 2010 was still the best April on record.

However, we have to ask ourselves how much of that good news was due to the overpowering ability of China’s factories, and how much was due an improving US economy? For that answer we have to look at market share. And here the news is not so good.

China’s US market share for April 2010 was in fact lower for than for the same month in 2009.

When we compare year-on-year changes, we see the full depths of China’s decline.

Part of the problem is FOB prices. We all know that China’s export factories are beneficiaries of many substantial government subsidies, and in turn pass these savings on to their customers.

Chinese factories have always operated on very slim margins, with operating profits typically below 4%. This has permitted them to provide their customers with ever lower prices.

2009 was the big drop: the US was in recession, US customers desperately needed lower prices – and China’s factories stepped in to provide those unbeatable prices with a reduction of 9.5%.

This is state capitalism at its best – government and industry working together to increase market share. 

However, all good things must come to an end, and that end appears to be now.  Despite the benefits of Chinese state capitalism with its many subsidies, Chinese factories have reached the limit of the goodies they can hand out to their factories. January-March looked good. April brought the end of the freebies.

From here on, we have to expect the FOB price of made-in-China goods to rise.

We know that the cost of made-in-China goods is rising. Labour rates are going up, and so too is the value of the yuan, China’s greatest subsidy.

How will this effect China’s garment exports?

So far the information is anecdotal. Customers are complaining about late delivery, and worse, no delivery at all. Every day I receive requests from customers to help them locate good factories outside of China. 

I have no idea whether this trend will continue: only a fool would bet against China’s unstoppable garment export industry. But then again, the same thing could have been said about Toyota, until we started hearing those stories about poor quality, unexpected acceleration and fatal accidents.

I think I should hold off predicting the demise of China, at least for a few months.  

However, there is a real danger here. For the past few years, customers have come to see China as an unreliable supplier. In the past this had nothing to do with Chinese factories or made-in-China garments, both of which were world-class leaders.

Instead, customers feared the growing anti-China feeling in their home countries which could lead to serious trade restrictions. To the major garment importers and retailers the imposition of anti-dumping duties or countervailing duties would be catastrophic.

Should penalty duties be imposed, the customer with 10,000 dozen T-shirts on order at a Chinese factory faces no real problem. You can always find a factory outside of China to accept your order. However, if you have a billion dollars’ worth of work in process in China your company is stuck and possibly dead. The problem was politics.

Now the problem has expanded. China has become an unreliable supplier in the usual sense – poor quality and late delivery. Ours is a very simple industry. All we care about is delivery and China is no longer delivering.

Interestingly, the Chinese do not see this. Like Toyota, they simply do not see that the road ahead leads to a big drop.

Winners invariably fall prey to hubris. They think they are invulnerable up to the moment they fall off the cliff.

The “I-am-a-winner-because-I-am-a-winner-because-I-am-a-winner-because-I-am-a-winner” syndrome continues up until the moment it ends and goes…PLOP. 

David Birnbaum is the author of The Birnbaum Report, a monthly newsletter for garment industry professionals. Each issue analyses in-depth US garment imports of four major products from 21 countries, as well as ancillary data such as currency fluctuations, China quota premiums and clearance rates.

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