South China Exports and Labor: Toy Industry Registers Some

UNCLAS SECTION 01 OF 03 GUANGZHOU 000528 SENSITIVE SIPDIS STATE FOR EAP/CM, EAP/EP, EEB/TPP, S/P, INR/EAP, DRL STATE PASS CONSUMER PRODUCTS SAFETY COMMISSION RICH O'BRIEN/INTL PROGRAMS STATE PASS USTR CHINA OFFICE STATE PASS HOMELAND SECURITY COUNCIL STATE PASS IMPORT SAFETY WORKING GROUP STATE PASS USTR FOR KARESH, MCCOY, RAGLAND, WEISS LABOR FOR ILAB - LI E.O. 12958: N/A TAGS: ETRD EIND ELAB PGOV ECON CH HK SUBJECT: South China Exports and Labor: Toy Industry Registers Some Improvement Despite Continued Weakness REF: A) GUANGZHOU 315; B) HONG KONG 649; C) GUANGZHOU 163; D) GUANGZHOU 47; E) HONG KONG 91; F) 2008 GUANGZHOU 618 (U) This document is sensitive but unclassified. Please protect accordingly. Not for release outside U.S. government channels. Not for internet publication. ¶1. (SBU) Summary and comment: Good news for one oQ south Qhina's beProfits are expected to decline by an average of 20% for the year, pick up in May and June, according to Guangdong-based contacts. Profits are expected to decline by an average of 20% for the year, mostly because higher unit costs have impacted firms' bottom lines. South China's labor shortage might best be described as a tight labor market in which skilled migrant workers appear unwilling to accept lower compensation caused by factories reducing overtime opportunities, and bosses are unable or unwilling to increase salaries to meet worker expectations. At the same time, industry contacts do not see Chinese domestic demand as a panacea for relieving pressure on toy export manufacturers. Export-oriented toy makers hoping to shift sales toward China's domestic market would need a well-executed market strategy implemented over 2-3 years if starting from scratch, according to contacts. There are no simple solutions to the manufacturing industry's challenges, but company owners are not waiting on luck either, instead they are actively working to improve their situation through mergers and acquisitions and additional cost cutting. End summary and comment. Overseas Toy Orders Now Flooding In... -------------- ¶2. (SBU) The year started slowly for Pearl River Delta toy manufacturers, but things started picking up in the summer. Top-tier south China toy makers should have received order forecasts in February and March if this were a "normal year", according to Eddie Wong of Silverlit Toys. However, this year skipped over the forecasting process entirely, going from almost no orders in the winter and spring to full order books in May and June. Wong said �0A;buyers this year waited until existing product inventories declined before placing new orders, unlike previous years when customers more aggressively projected overseas retail sales throughout the year, culminating with the all-important Christmas season. He also said major customers have "under-ordered" this year and some new toys have already sold out in Japan because buyers who might have purchased 20,000 pieces of a new toy in 2008 only ordered 8,000 for ¶2009. ...But Profits Trending Downward -------------- ¶3. (SBU) Executives from self-proclaimed market leader Jetta Toys also complained about late orders in a meeting with Econoffs last week. They said the company's total 2009 orders are projected to increase over 2008 numbers, but smaller batches in each order will mean higher unit costs and lower annual profits. Executive Vice President Li Zhuoming of the Guangdong Toy Association reinforced the individual companies' anecdotal reports, saying that Guangdong's gross toy exports dropped 15.8% year-on-year to US$ 5.326 billion, of which the United States accounted for US$ 1.717 billion in direct exports. When asked about costs, individual toy makers and industry representatives repeated frequently cited complaints about higher regulatory and testing costs, unfavorable exchange rate fluctuations, increasing labor costs, and pricing pressure from overseas buyers. Labor Shortage in South China? -------------- ¶4. (SBU) When asked about recent news reports of a labor shortage in south China, toy company executives all said they have had trouble GUANGZHOU 00000528 002 OF 003 recruiting enough skilled workers since orders picked up in May and June. Silverlit executives blamed the situation on poor timing and the lack of overtime pay for workers. They said many "early bird" returnee workers had been turned away during and after Chinese New Year due to depressed overseas orders (ref D). Hiring did not resume until order books started to fill in late spring and early summer, by which time many migrant workers, including skilled workers, had either found other jobs, resolved to return home until economic conditions improved, or left the area to search for work in other parts of China. ¶5. (SBU) Reduced overtime pay for workers was another key factor making it harder for manufacturers to recruit skilled workers. Executives from both Silverlit and Jetta said workers had come to expect overtime in recent years as a way to significantly boost income, but they were less willing to return to assembly line jobs once factories cut overtime opportunities to save money during the economic downturn (ref C). Additionally, Jetta executives claimed that increased perks for China's rural population, including low or no taxes for farmers and a variety of other subsidies, caused many migrant workers to view low-paying manufacturing jobs as less alluring. ¶6. (SBU) For all of these reasons, and despite total toy orders matching or exceeding 2008 numbers, Jetta executives said their current workforce of 30,000 was down 25% from the group's full capacity of 40,000. On the other hand, executives at Silverlit's single medium-sized factory of 5,000 said they were operating at almost full capacity and could not hire and train workers fast enough when the orders picked up in June and July. Silverlit requires new employees to attend almost three full days of quality and safety training before starting workers on assembly lines, but turnover had been higher than normal this summer, further increasing production costs and making it harder to optimize staffing patterns, according to executives. Can Domestic Demand Save the Day? -------------- ¶7. (SBU) Li Zhuoming from Guangdong Toy Association said China's domestic consumer market is simply not big enough to digest billions of dollars in toy products that are exported to overseas markets each year, even if overseas sales declined and toy prices dropped to better coincide with Chinese consumers' expectations. Li estimated that it could take an export-oriented toy manufacturer 2-3 years to begin successfully competing in China's domestic market, with certain structural differences like longer settlement periods for domestic buyers making it even harder for smaller producers to shift from export-only sales to a combined approach. ¶8. (SBU) Silverlit executives separately offered similar doubts about seeing a sudden surge in domestic orders, despite recent increased market share of their radio-controlled product lines at major Mainland department stores. Silverlit said China's market was just as complex as any other major retail market, requiring successful establishment and ongoing management of logistics and supply lines, sales and marketing networks, and retail contracts. Jetta executives said the end result for them was a long-term strategic decision that the company would not compete in China's domestic market, and continue to focus on the U.S., Europe and Japan for most sales. Present and Future Outlook: Business Goes On -------------- ¶9. (SBU) Guangdong toy industry contacts said cost cutting would remain key to their strategies and predicted that market conditions would gradually improve for the second half of 2009 and first half of 2010. Profits were predicted to decline by an average of 20%, as GUANGZHOU 00000528 003 OF 003 would total toy exports, which would mean continued challenges for manufacturers, although strong firms would also find opportunities amid the market turmoil. Executives at both Silverlit and Jetta said their companies had acquired smaller firms in the last nine months, but that mergers and acquisitions (M&A) in the industry were not happening at a fast pace. They said that because China's laws and financial system are not yet as developed as those in Hong Kong, Europe or the United States, the easiest way to acquire another firm was to complete the transaction overseas but consolidate the manufacturing operations in Guangdong once ownership had been transferred. ¶10. (SBU) Li Zhuoming of Guangdong Toy Association also voiced cautious optimism for the industry, pointing out that even during its darkest winter, a record number of Guangdong-based toy manufacturers exhibited at the Hong Kong International Toy Fair in January 2009 (ref E). Li said the strong showing by local firms meant the industry was weathering a stormy economy and anticipating a stronger outlook. Jetta executives also said that although they could not predict next year's economic situation, their company's charity/corporate social responsibility (CSR) funding remained steady in 2009. Jetta maintains a RMB 1 billion fund (US$147 million) that supports hundreds of local schools in rural communities that are factory workers' hometowns. GOLDBECK