By Susan Fenton
Thursday, March 5, 2009
HONG KONG: China's hopes for a speedy export recovery from the global crisis could be undermined by the weakest links in its powerful supply chain - smaller companies too damaged by the downturn and credit crisis to get goods to market.
As collapsing sales to recession-hit Western markets weigh on China's economy, bankruptcies pose a growing risk to its export machine, threatening everyone from suppliers of crucial parts and materials to companies that transport finished products.
Struggling Chinese exporters are facing higher costsand need to keep closer checks on suppliers, and a shrinking pool of financially healthy companies to deal with is limiting their vaunted flexibility, slowing down delivery times.
"The financial crisis is creating a situation that is unparalleled. If a Chinese company cannot sell to a Hong Kong company, which in turn cannot sell to, say, a foreign department store, each of their businesses will be affected," said Satpal Gobindpuri, a partner in Hong Kong at the DLA law firm. "It's creating a domino effect."
PricewaterhouseCoopers estimates that 670,000 small companies have closed across China because of the global crisis.
In addition to tumbling exports, companies have been hit by a squeeze in credit markets. About 90 percent of world merchandise trade is funded by trade finance, such as letters of credit.
A report Wednesday showed that factory output and new orders had returned to mild growth in February after shrinking for four months, though analysts cautioned about reading too much into the rise.
Wing Fung Optical International of Hong Kong, which makes sunglasses and eyeglass frames in the southern Chinese city of Shenzhen, has seen sales skid 25 percent in recent months as demand shrank in its key markets, Italy and the United States.
But its director of business development, Raymond Chan, said recent bankruptcies among suppliers posed a bigger risk to the company.
When a parts supplier went bust recently, sending Wing Fung scrambling to find an alternative source that could offer the same quality, delivery on a U.S. order was held up by two weeks - a delay that could have cost Wing Fung its customer.
"Delivering on time is crucial if we want to stay competitive," Chan said.
Adding to the problem is that many owners of small businesses in China arerunning away and leaving their companies in legal limbo, often just posting a notice on the factory door. Customers are left in the lurch with no chance of getting back any money owed or receiving goods they have ordered.
"They see no point in winding up operations properly if they don't have assets to pay creditors and workers," said Gobindpuri, the Hong Kong lawyer.
The risk-consulting company Kroll said it had seen a surge in demand for checks on Chinese suppliers. Red flags include workers not being paid on time or being laid off, delays in delivery times and a sudden shift to a new business.
"If a supplier is moving into another area of business, they're doing it for a reason," said Jack Clode, the Kroll managing director of business intelligence and investigations. It also means the existing "customer may no longer be a priority."
Clode, who foresees a sharp increase in factory closures in China this year by midsize Western companies as their domestic demand evaporates, said financial strains were also prompting suppliers to cut corners with cheaper materials.
Wing Fung, the eyeglass maker, has cut its number of suppliers by a quarter in recent months, dropping those that are late paying their bills. It also said it was extending credit to longstanding, reliable suppliers who are having short-term financial difficulties.
Chinese manufacturers are also growing worried about the health of their customers in the West as economies there worsen.
For the first time, Kroll is being asked by Chinese companies to conduct due diligence on Western customers.
"Li & Fung set off alarm bells," said Clode, referring to the Hong Kong blue-chip, global supply-chain manager.
Li & Fung sources goods for Wal-Mart Stores, among others, and is the biggest creditor of KB Toys, the former leading U.S. toy retailer.
When KB Toys filed for Chapter 11 bankruptcy protection in December, Li & Fung was owed $5 million.
Wing Fung was also caught last year when an Italian wholesaler suddenly went out of business. The Hong Kong company is still awaiting payment for goods, but does expect to be paid eventually, which is not the case with its bankrupt Chinese suppliers.
While rising bankruptcies are raising the risk of doing business in China, the country is unlikely to lose its status as a low-priced global trade center, not least because many companies are focused on the country's huge domestic market in the long run.
A survey of multinational companies in China, released this week by the U.S.-based management consulting company Booz & Co., showed that 90 percent of 108 respondents said they had no plans to relocate from China, up from 83 percent in a similar survey a year ago. Executives cited China's domestic market as the main reason for staying put.
The chip maker Intel recently announced it would close plants in Malaysia and the Philippines but would stay in China, relocating from Shanghai to Dalian in the northeast and Chengdu in the west, where land and labor costs are lower.
Wing Fung has also considered shifting within China rather than leaving.
"Everything is available in China, all the parts," Chan said.
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