Exports were booming back in 2007, but it wasn’t all good news. Remember Mattel? In August of last year, the world’s largest toy manufacturer issued a recall of 19 million of its China-made products, due to excessive levels of lead paint as well as faulty design.
The recall became the symbol of all that was wrong with China’s exports in a year that saw high-profile recalls of a broad range of goods from pet food to toothpaste. The "made in China" brand, it seemed, had never been lower. Beijing took steps to repair its image, setting up a national recall system and revising safety standards, and product safety was pushed to the back of the public’s consciousness.
Then the dairy scandal hit. Starting in early September, high levels of the industrial chemical melamine were discovered in Chinese dairy products ranging from powdered milk to infant formula.
The key issue was cost. Milk was being watered down to increase volume and thereby raise sales, and melamine was used to raise the apparent protein content of the diluted product in tests. Four infants died and global concern about the safety of Chinese products reignited.
Tip of the iceberg
While food was the focus on this particular occasion, experts believe safety issues are pervasive across many industries.
"I think the food safety issue has driven home the fact that we are still just at the tip of the iceberg in understanding the full extent of the corners being cut in the supply chain," said Alexandra Harney, author of The China Price, which examines the human and environmental costs of China’s manufacturing boom.
These most recent product safety scandals have amounted to nothing less than a PR disaster for China. However, few see product safety concerns changing the fundamental need for cheap Chinese-made goods, particularly during a global economic crisis. While Beijing is committed to improving the safety of its products, real change will require a fundamental shift in manufacturing processes that It will take years, if not decades, to occur.
"Everybody is concerned about product safety, but there’s still demand and the need to get products from China because, for a lot of product categories, there’s just no other option," said Thaddaeus Mueller, business development manager at Fiducia Management Consultants in Hong Kong, which advises Western companies with sourcing and manufacturing interests in China.
But China’s manufacturers are hurting. Export growth fell to 19.2% year-on-year in October from 21.5% in September, well below the year high of 30.3% reached in March. Over 67,000 factories are reported to have closed down, which has, in turn, led to a rise in labor disputes and protests over unpaid back wages.
On top of this, the manufacturing sector is facing a bevy of margin-thinning challenges: rising labor costs, government policies aimed at moving manufacturers up the value chain, stronger enforcement of environmental regulations, and more stringent requirements for product safety.
As costs rise, so does the potential for problems within the supply chain.
"There’s a huge rise in subcontracting as a result of rising business costs," Harney said. "Subcontracting often means that you have less control of your supply chain and that increases the likelihood of people substituting subpar materials."
Indeed, subcontracting is at the heart of most product safety issues in China. A subcontractor was blamed for supplying the lead paint that forced Mattel to issue massive recalls of its Chinese-made toys in 2007. In a grisly development, Zhang Shuhong, the owner of Lee Der Industrial, the contracted firm that produced the toys, hanged himself in a factory warehouse shortly after the scandal broke.
Although experts who spoke to CHINA ECONOMIC REVIEW were divided as to whether Mattel could have avoided the crisis with better controls, most agree that it would be difficult to know if a subcontractor had provided them subpar material. Furthermore, they saw safety as a problem throughout China’s supply chain.
"I’d say [the safety concerns] are not overblown," said David Levy, general manager at a US factory in Dongguan, Guangdong province. "I deal with raw material vendors and subcontractors and we come across a lot of quality issues."
Rising costs and a spotty record on product safety have led some firms to begin looking beyond China for alternatives.
Connie Carnabuci, a partner with law firm Freshfields in Hong Kong, who advises multinationals doing business in China, said some of her clients have begun looking at other options such as India or Pakistan. But they’re not giving up on China. "Does it mean that China will immediately cease to be a source of supply? No. Does it mean that everyone needs to be more vigilant? Yes."
Vietnam has long been offered as a potential destination for manufacturers who are disillusioned with China. Experts said that some companies in low value-added industries are indeed making the move, attracted by a cheap labor force.
However, China continues to boast significant advantages over its Southeast Asian competitors. These include a history of manufacturing; the "cluster effect," in which different pieces of the supply chain are located within several hours of each other, leading to greater efficiencies; and infrastructure. Mark Millar, vice chairman of Supply Chain Asia, noted that Vietnam’s ports are running 20% over capacity, and that new facilities won’t come online until 2010.
Neither can Vietnam match China in producing goods with any complexity.This complexity could range from certain types of stitching on a garment to a small motor for a toy.
"I don’t personally know anybody who successfully moved to Vietnam. I hear people talking about it, but I don’t see people doing it," said Levy. "I also know of companies who have started, and have put a halt to their Vietnam project."
Levy added that Vietnam’s great advantage – cheap labor – might disappear should Taiwan and Hong Kong firms move their manufacturing operations there en masse. While that could be ameliorated somewhat by bringing in additional labor from neighboring countries such as Cambodia or Laos, managing a multilingual, multicultural workforce would present a new slate of challenges.
The status quo
Insiders and analysts agree that while there may be an eventual shift in manufacturing to countries like Vietnam, such a shift would take years to occur. In the meantime, Western firms will continue to manufacture in China, and China’s manufacturers will have to contend with increased demand for product safety from their Western customers.
People see two competing and not mutually exclusive scenarios playing out regarding product safety. In the first, the economic slowdown could facilitate consolidation that weeds out the bad actors, thus making products safer.
"The milk scandal, coinciding as it did with the economic crisis, caused a bit of a perfect storm. Your dependency on products and product quality is heightened, because you can’t afford to put anything substandard into the market when there’s less money around," Carnabuci said.
The other scenario is less rosy. The global financial crisis could increase the demand for cheap goods, which would lead to more subcontracting and corner-cutting on raw materials or components.
Raising the bar
Those in the industry expect foreign importers to require that Chinese products undergo more extensive testing and verification, putting more pressure on manufacturers’ margins. This has already happened in the toy industry, where many Chinese factories have been driven out of business by stringent safety demands. But while testing and verification are necessary measures, they are by no means a cure-all.
"Logistically, you cannot test every component that’s going into your products 100% of the time. It takes a week to get the results back, so are you going to freeze the factory for a week?" said Benjamin Schwall, owner of Systems Technology Group (STG), a purchasing and quality control company in Dongguan.
The real solution lies not in testing the final product, but rather in ensuring the integrity of the entire supply chain and manufacturing process. Product safety is only one part of quality control; one must also ensure, for example, that the product has been painted the right color. Making safe products, manufacturers say, is part and parcel of better business practices.
The vast majority of Chinese manufacturers, for all their vaunted skill, remain inefficient. One insider, on a recent factory visit, recalled seeing about US$1 million worth of products sitting idle on the factory floor. Others savings could come through conserving water and energy and investing in better machinery.
Removing these inefficiencies will go some way to removing the underlying reasons for cutting corners on product safety. "What you’ll find is if you reduce the waste in the organization there’s less pressure to cut costs," said Levy.
Making these changes does not come without a price. Levy said the top-notch production programs used by the likes of GE or Toyota are difficult to adopt in small, cost-conscious Chinese firms. Even cherry-picking the best practices can help turn a factory around, though.
"If you take aspects of those companies, manage their production and you employ them in a very practical way, you can improve the value of your production and the value of your organization," he said. "And you can do it fairly quickly."