Hong Kong Manufacturing SMEs: Preparing for the Future

Hong Kong Manufacturing SMEs:PREPARING FORTHE FUTUREFunded by SME Development FundMade in PRD Research Series III

Funded by SME Development FundHong Kong Manufacturing SMEs: Preparing for the Future is a project of the Federation of Hong Kong Industries. It was funded by the SME Development Fund of theTrade and Industry Department, HKSAR Government, and undertaken by Enright, Scott & Associates Ltd.Copyright 2010 Federation of Hong Kong Industries. All rights reserved.No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior writtenpermission of the Federation of Hong Kong Industries.Published byFederation of Hong Kong Industries31/F, Billion Plaza, 8 Cheung Yue Street, Cheung Sha Wan, Kowloon, Hong KongTel: (852) 2732 3188Fax: (852) 2721 3494Website: www.industryhk.orgEmail: fhki@fhki.org.hkDisclaimer: any opinions, findings, conclusions or recommendations expressed in this material/event (or by members of the Project team) do not reflect the views ofthe Government of the Hong Kong Special Administrative Region, Trade and Industry Department or the Vetting Committee for the SME Development Fund.

ContentsForeword 2Executive Summary 4Issues for Hong Kong Manufacturers in the PRD 8The Global Economic Environment 8Cost and Related Issues 12Legal and Regulatory Changes 18Competitive Environment 24Chinese Mainland Policies Affecting Operations in the Pearl River Delta 25Operational and Strategic Issues 30The Impacts of Developments on Hong Kong Manufacturing Firms 33Greater PRD Business Council/ Hong Kong Trade Development Council (June 2007) 33Hong Kong Trade Development Council (November 2007) 34Hong Kong Trade Development Council (February 2008) 35Federation of Hong Kong Industries (March 2008) 36Hong Kong Trade Development Council (September 2008) 38Federation of Hong Kong Industries (May 2009) 39Federation of Hong Kong Industries (November 2009) 40Hong Kong Shippers’ Council (November 2009) 41Hong Kong Trade Development Council (January 2010) 42The Chinese Manufacturers’ Association of Hong Kong (April 2010) 43Industry Situation Reports 45The Watch and Clock Industry 45The Consumer Electronics Industry 55The Garment Industry 65The Mould and Die Industry 75The Toy Industry 85Strategies to Meet the Challenges Facing Hong Kong Manufacturing SMEs 97Strategies to Deal with External Challenges 97Strategies to Deal with Internal Management Challenges 105Questions that Hong Kong SMEs Must Answer 113Potential for Collective Action 114Conclusions 116Looking Back 116New Pressures 118The Need for Reinvention 118The Present Report 119Acknowledgement 120

2ForewordOn behalf of the Federation of Hong Kong Industries, I would like to present this report to Hong Kongmanufacturing SMEs. As the third study under our “Made in PRD” Research Series, this study aims toprovide them with practical guidance on dealing with the challenges emanating from reduced demand ininternational markets in the aftermath of the global financial crisis, and, in particular, recent changes in thePRD operating environment.Since the FHKI embarked on the “Made in PRD” Research Series in 2001, two reports have been releasedin 2003 and 2007, respectively. They looked into the emergence and growth of the PRD as a productionhinterland of Hong Kong industries, the economic synergy between Hong Kong and the PRD, and the pivotalrole played by Hong Kong manufacturers in driving the industrial, economic and technological developmentof this rapidly evolving region. Their findings and recommendations not only helped local manufacturing andservicing companies in formulating business strategies, but also provided a direction for furthering the HongKong/PRD synergy and harnessing the business opportunities this would bring to our industries. We weregratified to see that a number of the measures recommended in our previous reports had been adopted bythe authorities. These measures have greatly facilitated the production operations of our manufacturers andfostered the industrial growth of the region.Since the publication of our last research report, the PRD business environment has become more challengingfollowing a series of changes in government policy and the global financial tsunami. First, the shifts inprocessing trade policy at the national level have deepened. Second, steps to restructure and upgrade thePRD industrial landscape have been speeded up, driving low value-added, labour-intensive, polluting andresource-depleting industries against the wall. Then, in the midst of this restructuring, the global financialcrisis broke out, hitting many export-oriented factories in the PRD.While orders from major overseas markets have begun to pick up gradually with the crisis receding in thesecond half of 2009, they have remained off the pre-crisis levels by a significant margin. Aside from industrialpolicy shifts and demand contraction, Hong Kong manufacturing SMEs are faced with other pressingchallenges due to changes in the operating environment in the PRD. These include worker shortages, labourcost escalation, appreciation of the Renminbi and stronger regulatory pressure.In order to offer Hong Kong manufacturing SMEs expert advice on overcoming these challenges andenhancing competitiveness, the FHKI commissioned Professor Michael Enright and his research team inFebruary 2010 to undertake the present study. Professor Enright is one of the world’s reigning strategy gurusand has published books and papers extensively on the PRD industrial development.

3In this report and the accompanying “SME Advisory Kit”, there are detailed analyses of the policy, economicand operating issues confronting Hong Kong manufacturing SMEs, as well as recommendations on strategicoptions which they may adopt to tackle these issues according to their individual circumstances. This reportalso examines the present situations of five industry sectors of importance to Hong Kong, namely, garments,consumer electronics, toys, watches and clocks, as well as mould and die manufacturing. Case studies ofHong Kong firms in these sectors that are adjusting to the current challenges are provided as real worldexamples that others may wish to follow.It is worth noting that the “SME Advisory Kit” is specially designed as a handy reference guide formanufacturing SMEs in preparing for the future. It sets forth the major external and internal challengesthey commonly face and gives guidance on how to map out strategies and action plans to address thesechallenges. There is also a list of key sources of information and support available to manufacturing SMEs.Based on the findings of this study, the FHKI is drawing up recommendations to the SAR and GuangdongGovernments on ways to enhance support for Hong Kong manufacturing SMEs operating in the PRD, so as tomaintain the vibrancy and competitiveness of the PRD manufacturing base. Our recommendations will coverareas including industrial upgrade and transformation, clean production, domestic sales, sourcing workers,and regulatory compliance. We look forward to their positive response to our recommendations.Finally, I would like to express gratitude to the SME Development Fund administered by the Trade andIndustry Department for funding this research project. I also wish to thank the sponsors for their generoussupport and members who participated in the project for their valuable input and advice.Cliff K. Sun BBS, JPChairmanFederation of Hong Kong IndustriesOctober 2010

4Executive SummaryHong Kong manufacturing firms in general and small and medium-sized enterprises (SMEs) face enormouschallenges. A global economic downturn, rising costs, increasingly challenging regulatory and legalenvironments, increasing competition, and the overall direction of policy in the Chinese Mainland havecombined to create a very difficult situation for Hong Kong manufacturing SMEs. The Hong Kong companiesinterviewed for this study indicate particularly difficult challenges associated with market declines, thebargaining power of customers, labour availability and cost, more stringent regulatory and administrativerequirements, competitive asymmetries, the emergence of capable Chinese competitors, and policies to alterthe industrial structure of Guangdong at the expense of traditional industries. The interviews also indicatedthat many Hong Kong SMEs suffer from a number of internal problems or inefficiencies including lack of aclear strategy, shortcomings in basic management techniques, a failure to differentiate, gaps in succession,difficulty in finding capable managers, difficulties in obtaining finance, and lack of knowledge of SME supportprogrammes that do exist.Many of the insights from the interviews with regard to the external environment echo and amplify theresults of a series of surveys and reports focusing on Hong Kong manufacturing firms that have appearedover the last few years. In these surveys and reports, Hong Kong manufacturing firms have reported that themost difficult challenges they face involve costs, labour rules, changes to export processing rules, shortagesof power or water, and changes in tax rules. The surveys and reports also indicate a number of strategies andapproaches that Hong Kong manufacturing firms have taken, or plan to take, in order to meet the challengesthey face. These approaches include improving technological capabilities, improving business processes,developing own designs or brands, shifting locations within China, shifting to locations outside of China, oroutsourcing production. Several interviewees noted that such shifts are not at all easy and may be outside thepresent capabilities of many if not most Hong Kong SMEs. If all else fails, a number of companies report thatthey may opt to shut down, potentially ending the contribution that they make to the Hong Kong economyand the economy of South China in general.More detailed analysis of the electronics, watch and clock, garment, toy, and mould and die industriesprovides additional insights into the challenges that Hong Kong manufacturing SMEs face and the strategiesthat some firms are using to meet these challenges. We note that a variety of strategies are being usedsuccessfully by different firms to deal with the challenges they face. There appears to be no single recipe forsuccess for Hong Kong’s manufacturing SMEs. Instead, successful companies continually assess the presentand future state of their industry, understand the advantages and disadvantages of different locations,identify defensible market niches, gear their strategies in an internally consistent way to meet the needs ofcustomers in the relevant niches, manage internal operations effectively, and find ways to get the most out ofthe workforce.In terms of dealing with the external environment, our results indicate that it is important for SMEs to developcost reduction strategies, differentiation strategies, labour market strategies, business model strategies thatdetermine the precise scope of the firm, geographic market strategies, and regulatory and policy-relatedstrategies, and that they consider exit or consolidation strategies. These strategies are not mutually exclusive.In fact, companies will have to make choices in all of these areas and they may choose to keep the status quoin some areas while making changes in others. We do note that the managers interviewed for this projectwere in general agreement that across the board status quo strategies (i.e. changing nothing) was unlikely tolead to success for most of Hong Kong’s manufacturing SMEs.

5Cost reduction strategies may include improving efficiency within the factories; automating productionprocesses; improving efficiency in logistics, distribution, and other activities; outsourcing business processes;relocating to other places in China; relocating to other countries, mostly probably in South or SoutheastAsia; and relocating along with similar firms (group action instead of individual firm action). Differentiationstrategies include improving product quality, improving services to customers, moving from OriginalEquipment Manufacturing (OEM) to Original Design Manufacturing (ODM) or Own Branding Manufacturing(OBM) production, tailoring strategy to serve particular niches, and supplying high value market segments.Labour market strategies may include engaging in more active recruiting, understanding that highturnover is costly, increasing wages, providing better working environments, instituting effective performanceevaluation schemes, shifting production to sources of labour, developing managerial talent from the ChineseMainland, bringing in managerial talent from elsewhere, and sharing the wealth with management talent.Business model strategies include shifting from manufacturing to outsourcing production, becominga trader or agent for other companies, becoming a subcontractor, and forward integrating into retailingor selling direct to end customers. Geographic market strategies include expanding to new OECDmarkets, the Chinese Mainland, and other developing country markets. Regulatory and policy-relatedstrategies include strategies to deal with environmental and product safety regulations, strategies to dealwith administrative requirements, strategies to deal with policies to restructure or upgrade local economies,strategies to leverage policies in support of SMEs, and relationship management strategies to ensure goodrelations with government. Exit or consolidation strategies include selling out or shutting down, changinglines of business completely, and consolidating the sector by acquiring other firms or investing to beat themin the market place and grow organically.In terms of dealing with internal managerial challenges, it is important that SMEs pay sufficient attention toselecting businesses in which to compete; formulating compelling strategies or business plans, understandingcustomers; understanding competitors; developing clear competitive advantages; financing operations andfinancial management; administering the firm; keeping up to date on market, technological, and managerialdevelopments; marketing and selling to existing and potential customers; and reducing dependence onindividual customers and suppliers; as well as dealing with additional challenges that may arise.In order to select businesses in which to compete, SMEs should link to the knowledge and skill set of theSME owner and managers, understand the ease of entry, understand where the firm can be unique, focus onindustries where the SME has a “good idea,” and focus on industries where there are unmet market needs.In formulating compelling strategies or business plans, SMEs should develop a clear vision, identifyclear target markets and customers, identify what customer needs are to be met, determine what the firmcan be best in, set clear goals for the company, identify the key functional policies necessary to carry out thestrategy, think through different alternatives to get where the company needs to go, identify and arrangethe resources necessary to carry out the strategy, implement the strategy properly, and understand when tochange strategy. To understand customers, SMEs should use the ”order” as starting point, think aboutnew ways to create value for the customer, explore ways of expanding business with existing customers,anticipate developments within customer companies, and reassess the attractiveness of customers from timeto time. Understanding competitors involves learning about competitors from multiple sources, assessingthe different types of competitors, reverse engineering competitor strategies, reverse engineering competitorcost positions, tracking competitor initiatives and building competitor profiles, and remembering not tounderestimate competitors.

6Without clear competitive advantages there is no way an SME can beat its competitors. Developing clearcompetitive advantages requires the SME to develop superior vision, superior knowledge, superiorresources, superior capabilities, or developing combinations of advantages. In order to succeed in marketingand selling to existing and potential customers, SMEs should focus marketing on firm advantages, focuson high-value issues of customers, understand the 80/20 rule (for most SMEs 80 per cent of sales comefrom 20 per cent of customers), estimate the cost of acquiring and serving particular customers, understandthe value of “post-sales marketing,” use a range of marketing tools, and ensure that payment and creditterms are well understood and due diligence is performed on customers. Success in financing operationsand financial management involves developing strong relationships with banks, establishing credit lines,considering SME support programmes, using asset-backed financing when necessary, instituting strongcash management policies, keeping enough cash in the business, institute a minimum cash balance policy,assessing creditworthiness of customers carefully, pursuing payment aggressively, taking advantage of termson payables, understanding key financial ratios and reports and using them as management tools, andperiodically “stress testing” the SME’s financial position.In administering and managing the firm, SME management should ensure legal and regulatorycompliance, implement suitable workplace safety regulations to minimise on-the-job risks, provide ongoingtraining for staff consistent with the needs of the business, seek cost–reducing business processes, developstrong human resources policies, use IT effectively, set up strong sales procedures, set up strong purchasingprocedures, and set up strong monitoring and control functions. Keeping up to date on market,technological, and management developments involves using customer meetings, the business press, thetrade press, industry associations, government agencies, consultants, and others to stay up to date and notfall behind customers or the competition. Reducing dependence on individual customers and suppliersinvolves diversifying the customer base, seeking guarantees from customers that demand exclusivity, andidentifying multiple suppliers for key inputs. Meeting additional challenges that SMEs face involvesenhancing firm reputation and goodwill, seeking outside advice when necessary, managing governmentrelations carefully, developing long-term relations with key customers and suppliers, doing forward-lookingrisk analysis, and planning for succession.The challenges and strategies available to Hong Kong manufacturing SMEs lead to many questions that theSMEs need to be able to answer about their business:• Which strategy or strategies will the SME use to deal with cost pressures?• Which strategy or strategies will the SME use to differentiate itself to gain some pricing flexibility?• Which strategy or strategies will the SME use to deal with labour market pressures?• Which strategy or strategies will the SME use for its business model development?• Which geographic markets will the SME focus on?• Which strategy or strategies will the SME use to deal with regulatory and policy-related issues?• If exit or consolidation strategies are appropriate, which strategy or strategies will the SME use?

7In order to answer these questions, the SME will have to answer several other questions about their businessand business environment. These include:• What is the competitive balance among Hong Kong firms, between Hong Kong and Chinese firms,between Hong Kong and foreign firms operating in China, and between Hong Kong firms operating inPRD and firms operating in other locations?• What are the sources of advantage and disadvantage for each type of firm? What are the specific sourcesof advantage and disadvantage for the individual SME?• What is the specific cost structure of their own business in the PRD (or wherever they are located) versusother places today, and how is the comparison evolving?• Does the sector in which the SME competes have a future in Southern China, or should new locations besought urgently?• What are the customer segments that are available to the firm and what are the customer requirements inthe different segments?• For companies operating in the Chinese Mainland, how is their sector perceived by the Municipal,Provincial, and Central Governments? Does it get favourable, unfavourable, or neutral attention?• To what extent are environmental or product safety regulations important in the sector?• What new business models or activities might be open to the firm?• Which of the external issues is most pressing for their business?• Does the firm have a clear strategy targeting specific types of customers, with plans to satisfy their needs,with specific competitive advantages, and with the resources necessary to carry out the strategy?• Does the firm have a clear view of what it can and will do better than competitors?• Does the firm have the managerial, administrative, and operational capability to carry out the strategyeffectively? If not, how can these capabilities be obtained?• Does the firm have sound financial, marketing and sales, administrative, control, and risk managementprocesses in place?• Who will manage the firm into the future?• When might it be necessary or beneficial to engage in collective action with respect to supply chaindevelopment, relocation, or other issues?It will be very difficult for Hong Kong’s manufacturing SMEs to survive and thrive if they do not have goodanswers to these questions. On the other hand, developing good answers to these questions is the first stepin facing and meeting the challenges that confront Hong Kong’s manufacturing SMEs.

8Issues for Hong Kong Manufacturers in the PRDHong Kong manufacturing firms are facingextremely challenging times. Slowdowns in globalmarkets have resulted in disruption of traditionalmarkets and trade patterns. These difficultieshave added to the challenges that the HongKong firms were facing even before the globaldownturn. Several issues have emerged in recentyears that are making it more difficult for HongKong manufacturers operating in the Pearl RiverDelta. An appreciating currency, labour shortages,rising wages, higher material costs, and other costincreases are affecting the region’s cost position.At the same time, several changes in regulatoryand legal structures, such as changes in exportprocessing, labour and environmental rules in Chinahave made it more difficult for Hong Kong firms,particularly SMEs. Changes in the competitiveenvironment, particularly the rise in capabilities offirms from the Chinese Mainland, have altered thelandscape for Hong Kong manufacturing SMEs.Finally, changes in the overall policy frameworktowards the Chinese economy in general, andthe Pearl River Delta economy in particular,have created additional challenges as well. Thecombination of challenges will require creativestrategies and solutions going forward if Hong Kongmanufacturing firms are to be able to survive andthrive in the new environment.The Global Economic EnvironmentThe global economic environment has had asignificant impact on Hong Kong manufacturingSMEs. The global economic downturn that startedin 2008 has had a major impact on demand in thetraditional export markets for the Hong Kong firms.In addition, the downturn has exacerbated thedifficulties that Hong Kong manufacturing SMEsface when dealing with powerful, concentratedretailers in major markets.Exhibit 1.Real GDP Growth Performance and Forecasts %(April 2010 forecast)101581064620020022003200420052006200720082009201020112012201320142015-220022003200420052006200720082009201020112012201320142015-5-4-10WorldAdvanced economiesEmerging and developing economiesUnited StatesJapanIndiaEuro AreaChinaSource : IMF

9Exhibit 2. Exhibit 3.Global Stock Market Capitalisation(US$ trillion)Unemployment %7012United StatesEU 27JapanUK601050840630204102001/20063/20065/20067/20069/200611/20061/20073/20075/20077/20079/200711/20071/20083/20085/20087/20089/200811/20081/20093/20095/20097/20099/200911/20091/20103/20105/20101/20073/20075/20077/20079/200711/20071/20083/20085/20087/20089/200811/20081/20093/20095/20097/20099/200911/20091/20103/2010Source : World Federation of ExchangesSource : National sourcesInfluence of DemandThe global economic downturn that started in2008 has had an important impact on Hong Kongmanufacturing SMEs. Globally, world GDP growthin 2008 slowed down to 1.7 per cent from 3.9 percent in 2007, and world GDP in 2009 was 2.2 percent lower than in 2008. World trade growth in2008 slowed down to 3.6 per cent from 7.5 percent in 2007, and world trade in 2009 was 9.3 percent lower than in 2008. Major markets, like the US,EU and Japan went into recession in the last half of2008 and remained depressed throughout 2009.Only in the last part of 2009 and first part of 2010did global output and trade begin to rebound (seeExhibit 1). Stock market values peaked in October2007 and have still not nearly rebounded to theirpre-crisis levels (see Exhibit 2). Unemployment inkey economies reached very high levels that areexpected to persist for a significant period of time(see Exhibit 3).While the IMF and others gradually increasedtheir forecasts for global GDP growth in 2010,uncertainty surrounding public finance in Greeceand other European countries has raised the spectreof a prolonged period of slow growth in the OECDcountries, with high levels of government debt,higher taxes, higher interest rates, more bankdeleveraging, and higher inflation. Even with areturn to growth, it is projected that the US will onlyreach 2008 levels of GDP in 2010, Western Europein 2013, and Japan in 2014. 1 Similarly, US importsare not expected to reach 2008 levels until after2013, Western Europe until after 2011, and Japanuntil 2013. 2 The result is that the world economyis likely to generate on the order of US$100 to120 trillion less in GDP over the next eight to 10years than it would have if it had continued on thesame trajectory that it experienced in the 2000 to2007 period. World trade is also expected to havea trajectory far different than that before the crisis(see Exhibits 4 and 5).1 EIU, “Global Outlook,” May 2010.2 EIU, “Forecast,” 2009. IMF, World Economic Outlook Database,April 2010.

10Exhibit 4. Exhibit 5.World Trade(Base year 2004 = 100)(With crisis vs. Without crisis)World GDP(Base year 2004 = 100)(With crisis vs. Without crisis)240With crisis150With crisis220Without crisis145140Without crisis2001351801301251601201401151101201051001002004200520062007200820092/20102/20112/20122/20132/20142004200520062007200820092/20102/20112/20122/20132/2014Source : EIU; Enright, Scott & Associates, Ltd.Source : EIU; Enright, Scott & Associates, Ltd.Developing countries, particularly those in Asia andLatin America, have been the bright spot in theworld economy over the last few years. Stimuluspackages and domestic growth in places likeChina, India, Indonesia, and Brazil have resulted incontinued growth in East Asia and Latin America.However, as central banks around the worldcontinued to flood markets with liquidity into mid-2010, fears have grown that China, India, and Brazilin particular are getting into an asset price bubble,which could eventually burst with negative impactson those and other economies.3 IMA-Asia, “Asia Pacific Executive Brief,” April 2010.4 EIU, “Forecast,” 2009.5 Statistical Bureau of Guangdong Province.6 “China’s workers head home jobless,” The Straits Times,15 November 2008.The global slowdown had a dramatic impact onChina’s exports and those of Guangdong Province.China’s export growth has slowed down from 21.9per cent in the first half of 2008 to 13.6 per cent inthe last half of 2008, and further declined to -15.9per cent in the year of 2009. 3 It was projected thatChina’s exports would not reach 2008 levels until2012. 4 In Guangdong, export growth has sloweddown from 13.1 per cent in the first half of 2008to 6.5 per cent in the last half of 2008, and exportsin 2009 were 11.5 per cent less than in 2008. Thedownturn slowed Guangdong’s GDP growth from14.7 per cent in 2007 to 10.1 per cent in 2008 and9.5 per cent in 2009. 5 Reports surfaced of millionsof job losses in PRD factories and of some firms thatclosed up without honouring their obligations toworkers. 6

11Exhibit 6.Exhibit 7.Hong Kong’s Trade(HK$ billion)Guangdong’s Trade(US$ billion)350ImportsRe-exports45Exports300Domestic exportsTotal exports40Imports352503020025150201001510505001/20053/20055/20057/20059/200511/20051/20063/20065/20067/20069/200611/20061/20073/20075/20077/20079/200711/20071/20083/20085/20087/20089/200811/20081/20093/20095/20097/20099/200911/20091/20103/20105/20077/20079/200711/20071/20083/20085/20087/20089/200811/20081/20093/20095/20097/20099/200911/20091/20103/2010Source : Hong Kong Census and Statistics DepartmentSource : Guangdong CustomsThe onset of the global economic crisis promptednumerous initiatives in China. The CentralGovernment announced a RMB 4 trillion (US$576billion) national stimulus package. In addition,Guangdong Province announced its own stimuluspackage of RMB 2.3 trillion (US$331 billion). Policiesdesigned to limit price increases in the propertysector were replaced by policies to encourage thesector. Other favourable policies including subsidiesfor the purchase of autos and home appliances ledto substantial growth in these sectors. Policies thathad limited bank lending, particularly in coastalareas, were reversed, as were reductions in exporttax rebates and other restrictions on export-orientedindustries. The policy initiatives helped Chinaweather the global downturn, with comparativelystrong GDP growth of 8.5 per cent in 2009, andeven faster rates in the first few months of 2010.Guangdong’s exports in the first few months of2010 were similar to those of the same period in2008 (see Exhibit 6). Hong Kong also saw its tradedecline in the last part of 2008 and through muchof 2009. By March and April of 2010, however,Hong Kong’s trade figures had returned roughlyto the same levels they had achieved in March andApril of 2008 (see Exhibit 7). Despite the rebound,international markets remained weak and theoutlook for the region’s trade has been uncertain.Influence of Retail and Buyer Market StructureThe global economic downturn has exacerbatedthe impact of the development of powerful andconcentrated retailers and buyer industries. Thevast majority of Hong Kong SMEs sell their productseither directly on to retailers or to OEM customerswho then resell the goods under their own names.The global economic downturn has caused thesebuyers to push their suppliers particularly hard.Some have pulled orders, some have delayedpayments, some have rejected shipments onquestionable grounds, and some have shifted ordersto competitors or other locations.

12The pressure felt by the Hong Kong SMEs is due inpart to the concentration of buyers. In many OECDeconomies, a handful of chains dominate the retailindustry. These chains are known to be particularlydifficult and often price-sensitive buyers. Thepressure is also due in part to the fact that relativelyfew Hong Kong SMEs have sufficient capabilities toreally distinguish themselves from their competitors.In the absence of such distinguishing features, suchas unique designs, unique technological capabilities,unique ability to service customers, or unique abilityto assess markets, the Hong Kong SMEs are oftenleft to compete on the basis of price, a difficultsituation particularly in the midst of an economicdownturn.Cost and Related IssuesEven before the onset of the global economic crisis,Hong Kong manufacturing firms, particularly thoseoperating in the Pearl River Delta region, had beenexperiencing cost pressures from several directions.RMB AppreciationOne factor often mentioned as increasing costs forHong Kong manufacturing SMEs operating in theChinese Mainland is the appreciation of the RMB.The RMB appreciated by 3.3 per cent against theUS dollar in 2006, 6.9 per cent in 2007, and 6.4per cent in the first six months of 2008. From July2008 until May 2010, the RMB was basically flatagainst the US dollar (its value versus the US dollarchanged by 0.4 per cent in that period). The RMBappreciated by 4.8 per cent against the Japaneseyen in 2006 and by 0.8 per cent in 2007, beforedepreciating against the yen by 13.7 per cent in2008, appreciating by 1.9 per cent in 2009, and7 Interbank exchange rates from www.oanda.com, calculationsby Enright, Scott & Associates. Data in May 2010 is as of 20May 2010.8 C. Fred Bergsten, “Correcting the Chinese Exchange Rate:An Action Plan,” Testimony before the US House Ways andMeans Committee, 24 March 2010.9 Hong Kong Trade Development Council, “Cost Escalation andTrends for Export Price Increase,” 3 September 2007.appreciating by 0.5 per cent in the first five monthsof 2010. The RMB’s value changed -7.3 per centagainst the Euro in 2006, -4.2 per cent in 2007,+11.3 per cent in 2008, -1.8 per cent in 2009, and+11.2 per cent in the first five months of 2010. Interms of countries that could become competitorsfor export-oriented light manufacturing industries,the RMB’s change against the Indian rupee was+1.2 per cent in 2006, -4.5 per cent in 2007,+33.2 per cent in 2008, -4.6 per cent in 2009, and-3.8 per cent in the first five months of 2010. Thechange against the Vietnamese dong was +0.03per cent in 2006, +9.3 per cent in 2007, +15.7per cent in 2008, +7.0 per cent in 2009, and +2.2per cent in the first five months of 2010. 7 Exhibit 8shows the appreciation of the RMB versus selectedcurrencies over the past few years.International pressure for China to allow the RMBto appreciate grew substantially in 2009 andearly 2010. Countries like India and Brazil joinedthe US and European countries in calling for anappreciation. In testimony before the US Congress,economist Fred Bergsten claimed that RMB wasundervalued by approximately 25 per cent on atrade-weighted basis and 40 per cent versus theUS dollar. 8 Even though there was some reductionin pressure towards the middle of 2010 as China’strade surplus fell, it is expected that the RMB willeventually appreciate against major world currenciessignificantly.The Hong Kong Trade Development Councilestimated in 2007 that Hong Kong firms operatingin the Pearl River Delta had local content rangingfrom 20 per cent to 45 per cent of total costs,and averaging 30 per cent. This meant that anappreciation of the RMB against the currency oftrade settlement (usually US dollars) by 10 per centwould on average impose a three per cent increasein total costs. 9 This means that in US dollar terms,RMB appreciation added just 5.4 per cent to thecosts of Hong Kong firms in the PRD from 1 January2006 to 1 May 2010. This is far lower than onemight expect given the discussion in Hong Kongabout the RMB and the fact that in some surveys of

13Hong Kong manufacturing firms RMB appreciationwas listed as the most important issue increasing thecosts of Hong Kong firms. However, among HongKong manufacturing SME managers interviewedfor this study, there is anxiety regarding possiblefurther appreciation of the RMB. In the toy sector,for example, the increased costs resulting fromthe appreciation of RMB have been absorbed bythe manufacturing firms, and particularly by HongKong manufacturing SMEs. Further appreciation,particularly of the magnitude contemplated bymany analysts, could reduce profit margin to thepoint where the very survival of many Hong KongSMEs could be at risk. 10Exhibit 8.15014013012011010090Source : US Federal ReserveRMB Value vs Other Currencies(January 2005=100)US$JPYEURIndia R3/1/20053/4/20053/7/20053/10/20053/1/20063/4/20063/7/20063/10/20063/1/20073/4/20073/7/20073/10/20073/1/20083/4/20083/7/20083/10/20083/1/20093/4/20093/7/20093/10/20093/1/20103/4/2010Labour AvailabilityTraditionally, the export industries of Guangdonghave had a hard time finding sufficient workers tomeet growing demand. For example, Guangdonglabour officials reported a shortage of 2.5 millionworkers in 2006. In 2007, the demand forunskilled workers grew by 9.5 per cent and thatfor technicians by 20.4 per cent. 11 While demandfor workers fell dramatically with the onset of theglobal economic crisis in the second half of 2008,by May 2010 labour shortages had returned, withsome sources estimating that there was a shortageof two million workers in the PRD. 12 While someanalysts believed that this shortage was likely to befrictional in nature (i.e. it would take time to attractworkers back into the region after the economicdownturn saw many lose jobs), many companyowners and managers operating in the PRD believethat the labour shortage could become permanent.Some analysts have claimed that China is starting torun short of the 18 to 28 year-old and single cohortfrom rural areas that has been the dominant sourceof migrant labour for the factories of the PearlRiver Delta region. They note that China has on theorder of 120 million people aged 18 to 28 yearscharacterised as rural residents and an estimated100 million rural migrants already working off thefarm, leaving a relatively smaller number to add tothe migrant workforce. In addition, farm prices roseby over 30 per cent in the 2002 to 2007 period.After a short period of decline in 2009, the produceprice of agricultural products increased 6.7 per centin the first three months of 2010 on a year-on-yearbasis and the produce price of farming productsincreased by 13.7 per cent in the first three monthsof 2010 on a year-on-year basis. In the first quarterof 2010, the per capita cash income of the ruralpopulation increased by 11.8 per cent year-on-year,or 9.2 per cent growth in real terms, 13 affectingthe willingness of people to leave for the cities. Inaddition, the spread of China’s development toinland provinces, the large scale stimulus packagethat favoured inland areas, and the rapid growthof China’s service sector have provided competingopportunities for workers that might have otherwisegravitated to the coastal factories.10 ESA Project Interview, 2010-04-19.11 Guangdong Labor and Social Security Office.12 Chloe Lai, “Delta firms urge hukou reform amid laborshortage,” South China Morning Post, 17 April 2010.13 NBSC, “Further Expanding Momentum of China’s EconomicRecovery in the First Quarter of 2010,” www.stats.gov.cn.

14The implication is that there may be a permanentshortage of the types of workers generally employedby Hong Kong manufacturing SMEs in the PRDgoing forward. This concern was echoed by themanagers interviewed for this study. Intervieweesindicated that the global economic crisis made analready troubling situation worse because manyworkers without full-time employment returnedto their home provinces and have not returned.Many that returned in 2009 could not findwork. Some managers believe that many of thedisappointed workers will not come back again. 14Interviewees also pointed to the success of theChinese Government’s stimulus package in creatingemployment in interior provinces that have beenthe sources of migrant labour.Interviewees also expressed the view that the impactof an increasing male-female ratio and the onechild policy is now being felt in the manufacturingsector. Many assembly manufacturing industriesemploy young female labour, and there are nowfewer and fewer young females available for workin general. In addition, young women now havebetter educational opportunities and can becomedoctors, lawyers, teachers, and hotel workers,occupations that have higher status than jobs inmanufacturing. The growth of the service sectorand office employment in China is absorbing many14 ESA Project Interview, 2010-04-07.15 BMI estimated number, “Country snapshot: Indiademographic data,” India Defence & Security Report, Q12010.16 Minimum monthly wage in Ho Chi Minh City and Hanoi asreported in Pacific Bridge Inc., “New Minimum Wage Levelsfor Foreign Enterprises in Vietnam,” 3 March 2009. www.pacificbridge.com.17 ILO, Labour Force Survey (for persons aged 15 years andover).18 ILO, Labour Force Survey (for state-owned units, urbancollective-owned units and other ownership units).19 Department of Human Resources and Social Security ofGuangdong Province, “Guangdong’s new minimum wagestandards will be implemented starting 1 May 2010.” www.gd.lss.gov.cn.people that would have gone into manufacturing inthe past. Even within the manufacturing sector, thegrowth of the Yangtze River Delta, the Bohai Rime,and other parts of China creates competition forworkers. As a result, there are many more optionsfor young Chinese workers today than there were15 to 20 years ago when manufacturing in thePRD was the only option for many to get out ofsubsistence agriculture in the interior of China.Wage IncreasesLabour costs in the Pearl River Delta grewsubstantially from 2002 to 2008 due to rises in theminimum wage and greatly expanded demand forworkers. During this period, exports and industrialoutput from the Pearl River Delta and YangtzeRiver Delta regions grew in excess of 20 per centper year and 15 per cent per year respectively.Average migrant worker wages in China wentfrom around RMB 780 per month in 2004 to RMB1,000 per month in 2006. Minimum wages inthe main manufacturing cities of the Pearl RiverDelta were raised on the order of 18 per cent from2002 to 2006 and by another 10 per cent in 2007.During that period, many factories were payingsubstantially above the minimum in order to obtainworkers. As a result, average wages in the mainmanufacturing cities of the PRD grew by over 20per cent from 2002 to 2006 and another 10 to 15per cent in 2007.By 2008, the PRD was no longer considered aparticularly low cost location for unskilled or semiskilledlabour. According to the InternationalLabour Organisation (ILO) and Business MonitorInternational (BMI), in 2008, monthly wages inmanufacturing were on the order of US$57 inIndia, 15 US$69 in Vietnam, 16 US$87 in Indonesia, 17and US$290 in China. 18Since the minimummonthly wages were US$161 in Guangzhou,US$161 in Shenzhen, US$134 in Dongguan,US$134 in Foshan, and US$140 in Zhuhai, 19 thefigures indicate that most manufacturing workersin China earned well above the minimum. Takingthe apparel manufacturing industry as a specificexample, labour costs in 2008 were US$0.22 per

15hour in Bangladesh, US$0.33 per hour in Cambodia,US$0.38 in Vietnam, US$0.44 per hour in Indonesia,and US$0.51 per hour in India, while they wereUS$0.55-0.80 per hour in China’s inland andUS$0.86-0.94 per hour in China’s coastal area, 20further suggesting that China is no longer the lowcost location for manufacturing that it once was inrelative terms.While wages in the Pearl River Delta stagnatedfor a while with the onset of the global economiccrisis and export downturn in 2008, in 2010 severalGuangdong jurisdictions announced additionalminimum wage increases on the order of 20 percent. 21 Even with these increases, there were signs ofincreasing dissatisfaction with wages by workers inthe Pearl River Delta region. Foxconn provided a 70per cent rise for workers in some of its PRD facilitiesafter a number of suicides occurred among itsworkers in May 2010. In late May 2010, Honda wasforced to rise the wages of many of its employees bymore than 20 per cent to satisfy workers who hadstruck over the objections of the officially recognisedtrade union. These instances pointed towardsincreasing wage pressure over and above thestatutory increases. It should be noted that Foxconnhas indicated that it is likely to move on the order of300,000 of 400,000 jobs out of Guangdong in orderto have easier access to lower cost labour. It was notclear whether this would start a trend or not.In addition to wage rates, jurisdictions in Chinain general, and Guangdong in particular, havebecome more active in expanding the coverageof the social security system to more and moreworkers. The various insurance schemes now costemployers an amount that is 20 per cent to 30 percent of the wage bill. 22 Interviewees for the presentstudy also confirmed that rising social security costsand the introduction of separate social securitycharges are an issue for manufacturing firms inthe PRD. The cost increase is unwelcome and theseparate charges, all of which are administeredby separate bureaus and have separate recordkeeping requirements are seen as being extremelyburdensome, particularly for SMEs. 2320 www.emergingtextiles.com.21 “Guangdong raises minimum wage by 20% amid Chinainflation fears,” Financial Times, p.1, 19 March 2010.22 Enright, Scott & Associates estimates based on officialsources.23 ESA Project Interview, 2010-04-07.24 The minimum wage for Huadu, Panyu, Nansha, Conghua,and Zengcheng Districts of Guangzhou as of mid-2010 wereRMB 960 per month for full-time employees and RMB 5.52per hour for part-time employees. www.gzlss.gov.cn.25 The Zhuhai Municipal Government has set the minimumwage for full-time employees at RMB 960 per month and theminimum wage for part-time employees at RMB 9.2, per hour,higher than that mandated by the Guangdong ProvincialGovernment. www.zhldj.gov.cn. www.gd.lss.gov.cn.26 On 27 May 2010, the State Council approved the expansionof the Shenzhen Special Economic Zone to the whole city.Therefore, Bao’an and Longgang districts have been includedin the Special Economic Zone since 1 July 2010.Exhibit 9. Minimum Wage Rates Mandated by Guangdong ProvinceCategoriesMonthlyMinimum Wage( RMB)2008-09 2010Hourly MinimumWage for Part-timeWorkers (RMB)MonthlyMinimumWage (RMB)Hourly MinimumWage for Part-timeWorkers (RMB)1 860 8.3 1100 10.6 Parts of Guangzhou 24Applicable Areas2 770 7.4 920 8.8 Zhuhai 25 , Foshan, Dongguan, Zhongshan3 670 6.5 810 7.9 Shantou, Huizhou, Jiangmen4 580 5.6 710 6.9Shaoguan, Heyuan, Meizhou, Shanwei,Yangjiang, Chaozhou, Jieyang, Yunfu530 5.1 660 6.4 Selected counties in northern Guangdong51000 8.8 1100 9.8 Shenzhen SEZ900 8.0 1100 9.8 Shenzhen outside SEZ 26Source: Guangdong Government

16Exhibit 10.Exhibit 11.Commodity Prices(January 2005=100)Fuel Prices in Guangdong(RMB per tonne)320Industrial inputs10,000Petrol300Oil9,000Diesel280260240CopperIron ore8,0007,0002206,0002005,0001801601401204,0003,0002,0001001,0008001/20053/20055/20057/20059/200511/20051/20063/20065/20067/20069/200611/20061/20073/20075/20077/20079/200711/20071/20083/20085/20087/20089/200811/20081/20093/20095/20097/20099/200911/20091/20103/201023/3/200523/7/200523/11/200523/3/200623/7/200623/11/200623/3/200723/7/200723/11/200723/3/200823/7/200823/11/200823/3/200923/7/200923/11/200923/3/2010Source : IMFSource : Enright, Scott & Associates and Guangdong Price BureauThe Hong Kong Trade Development Councilestimated in 2007 that labour costs accountedfor 15 per cent to 30 per cent of the productioncosts of Hong Kong manufacturers operating inthe PRD. 27 If so, then a 25 per cent to 30 per centincrease in wage rates would result in a total costincrease of around four per cent to nine per cent.If we assume that wage increases in the PRD havetracked changes in the minimum wage (at least inpercentage terms), then since 2006, wage increaseswould have increased total costs by around six to13 per cent.27 Hong Kong Trade Development Council, “Cost Escalation andTrends for Export Price Increase,” 3 September 2007.28 IMF, “Primary Commodity Prices,” accessed May 2010.29 CNFOL, “Overview of the Adjustment in Oil Price in China,”April 2010. news.cnfol.com.30 CNFOL, “Overview of the Adjustment in Oil Price in China,”April, 2010. news.cnfol.com.Material and Utility CostsIndustrial input and utility prices have also beenrising in China. Rising global raw materials priceshave affected producers all over the world. FromJanuary 2006 to July 2008, global oil pricesincreased by 113 per cent, copper prices by 77 percent, and iron ore prices by 82 per cent. By May2010, with the global economic downturn, oil priceshad declined 36 per cent, and copper prices haddeclined eight per cent, while iron ore prices roseanother 26 per cent (see Exhibit 10). 28 In China, localprices of fuels and petroleum products were raisedon the order of eight per cent to 10 per cent during2006 to 2007 to encourage greater productionin the face of high international input prices thatwere causing losses in Chinese oil companies. 29 Bythe end of April 2010, the fuel prices in China hadrecorded another 16 per cent cumulative increaseover the prices in 2007 (see Exhibit 11). 30

17Utilities and sewage charges are also rising in thePRD. According to city officials, peak electricitytariffs rose 27.5 per cent in Foshan and Dongguanfrom 2004 to 2006, while sewage charges inDongguan rose by more than 200 per cent. 31 In2008, the electricity tariffs in Foshan and Dongguanrose another 5.7 per cent. 32 The average sewagecharge in Guangdong Province has risen from RMB0.35 per tonne in 2007 to RMB 0.68 per tonne in2008, and further to RMB 0.9 per tonne in 2009,representing an over 150 per cent cumulativeincrease. 33At the end of 2009, the provincialgovernment further raised the guidance price forindustrial sewage charge in the PRD to RMB 1.3 pertonne. 34 Again, the trend for input and utility pricesis clearly upward in the region.Administrative and Compliance CostsChina’s national, provincial, and local governmentsenacted a wide range of new rules, regulations, andlaws governing company operations in the 2006to 2008 time frame. These included a new labourlaw, new social security rules, new environmentalregulations, new export processing regulations, andseveral other measures designed to restructure thelocal, provincial, and national economies. Theseare described below. One of the results of thesechanges has been a vast increase in the cost ofadministration and compliance. Whereas companiesonce could make social security payments in asingle lump sum, at present companies have todeal with several different agencies and pay severalseparate charges. Whereas many workers in thepast did not have formal contracts, today the vastmajority of workers must have formal contractsas specified in the new labour law. In addition,scrutiny by tax bureaus, environmental regulators,and other government agencies has increased. Theadministrative and compliance burden has grownsubstantially, something that is difficult for SMEswith their limited number of personnel to manageadministrative and managerial tasks.Perspectives on Cost IncreasesCosts have been rising in the PRD and they willcontinue to do so. This is due to China’s economicdevelopment, growing labour shortages, and explicitpolicy within China and the PRD. The questionsfor the Hong Kong manufacturers is whether theincreases in costs render them uncompetitive inglobal markets versus producers operating in otherlocations and whether increased costs can bepassed on to consumers in international markets.While in the 2004 to 2007 time frame exportprices out of China were increasing on the orderof five per cent per year on average, the onset ofthe global economic crisis and the accompanyingdownturn in demand has made passing on costincreases much more difficult. Thus rising costs arelikely to continue to squeeze Hong Kong companiesthat do not find some way to distinguish themselvesfrom the competition sufficiently to obtain somepricing flexibility.31 Hong Kong Trade Development Council, “Cost Escalation andTrends for Export Price Increase,” 3 September 2007.32 Statistics from the Price Bureau of Guangdong Province.www.gdpi.gov.cn.33 “Guangdong Sets Hard Targets for Its EnvironmentalProtection,” Renmin net, 24 March 2010. big5.cctv.com.34 Guangdong Environmental Protection Bureau. www.gdepb.gov.cn.

18Legal and Regulatory ChangesDuring interviews conducted for the present projectrepresentatives of manufacturing SMEs indicated thatoperating in the PRD is becoming increasingly harddue to the changes in policies and regulations thatgovern their businesses. 35 A wide range of legal andregulatory changes were implemented in the PearlRiver Delta region in the 2006 to 2008 timeframe.Many of these served to make operating in the PRDmore difficult for Hong Kong manufacturing SMEs.Of particular importance have been changes inexport processing and related regulations, the newlabour contract law, and changes in environmentaland product safety regulations.Export Processing and Related RegulationsIn order to suppress export growth, to ease frictionswith its trade partners, to rein in the rapid increaseof its foreign exchange reserves, and to pushthe economy toward less polluting and highervalue exports, China adopted a series of policiesand measures in the 2006 to 2008 time frame.These included changes in export and importtariffs, adjustments in export tax rebate rates,and the issuance of a new restriction catalogueof commodities for the export processing trade.China claimed that these policies and measures willhelp transform and upgrade its labour-intensiveand low-end manufacturing and processingindustries, help balance its economic developmentbetween the coastal regions and the interior,reduce natural resource consumption, and helpcontrol environmental pollution. While some ofthese steps were reversed or not fully implementeddue to the global economic downturn that startedin mid 2008, it is likely that once the Chineseleadership determines that the crisis is over, theseand additional measures will be taken to reshapeChina’s manufacturing and export profile.35 ESA Project Interview 2010-04-07.36 www.mofcom.gov.cn.37 www.mofcom.gov.cn.38 Companies are categorised into four types (A, B, C, and D)based on their Customs records.Average export tax rebates in China were reducedfrom 16.3 per cent in January 1994 to 12 percent in September 2006. On 19 June 2007, theMinistry of Finance, the State Administration ofTaxation, the National Development and ReformCommission, the Ministry of Commerce and theGeneral Administration of Customs issued a circular“Adjustment of the Tax Rebate Rates for CertainExporting Products” that would adjust rebate ratesfrom 1 July 2007. 36 Export tax rebates for productsincluding some animals and plants, selectedchemicals, dyes, leather, some wood boards andrelated products, certain carbon welded pipes andproducts, a variety of nonferrous metal products,and non-motor vessels would be abolished. Rebaterates for many other products, such as garments,shoes, hats, furniture, bicycles, a wide range ofmachinery products, certain chemicals, plastic andrubber products, leather products, paper products,ceramics, and a variety of metal products would bereduced. The changes initially were to impact 2,831commodities representing 37 per cent of the totalnumber of items listed in customs tax regulations.Another 550 products were added to the list inNovember 2007. The Finance Ministry indicatedthat the cost of producing the commodities wouldincrease as a result of the changes to the exporttax rebate regime, that this would incite capitalinvestment to move to other “high value-added andhigh tech” industries and that in the long run, thiswould help the country develop in an economic andsustainable way.As approved by the State Council on 23 July2007, Announcement No. 44 introduced newcommodity restrictions for export processing.The new regulations, effective from 23 August2007, covered 1,853 Harmonised System CustomsCodes (HS Codes), in textiles, plastics, wood, andother low-end and labour-intensive industries,which represented 15 per cent of all the HS Codesin China. 37 Export processing enterprises in thecoastal regions industry those categorised as typeA 38 and type B enterprises by Chinese Customshad to put up a guarantee deposit equal to 50per cent of the amount of duty and value-added

19tax if they carried out export processing on goodsin the new restriction catalogue. 39 Type C exportprocessing enterprises had to put up 100 per centguarantee deposits, wherever they were situated. 40Announcement No. 44 also listed the types of firmsthat would and would not be allowed to engagein export processing in the specified commodities,with preferences given to companies set up ininland areas.With the onset of the economic crisis in mid-2008,China’s exports slowed. In an effort to ease thepressure on exporters and to stimulate exports,China increased export rebates in August 2008,November 2008, December 2008, January 2009,February 2009, April 2009, and June 2009. Theaverage rebate in Guangdong went from 12.21 percent in July 2008 to 14.28 per cent in June 2009. In2009, the total tax rebate for Guangdong was RMB146.55 billion, an increase of seven per cent yearon-year,and a historical high. China also adjustedits policies on the restriction and prohibition listsfor export processing. On 21 November 2008, 17furniture products were taken off the restrictedlist and cash deposit requirements for trading in1,853 commodities were suspended. The guaranteedeposit policy for another 122 commoditieson the restricted list was suspended for type Aenterprises, while those for type B and type Centerprises in Guangdong remained unchanged.On 31 December 2008, 1730 HS codes involvingtextile products, plastic products, wood products,and hardware products were removed from therestricted list. Those products, with an export valueof US$30 billion, accounted for 77 per cent of thetotal restriction catalogue. In addition, 27 HS codesinvolving copper, nickel, aluminium, and relatedproducts were removed from the prohibited list.Those products, with an export value of US$1.5billion, accounted for 30 per cent of the totalprohibition catalogue. On 3 June 2009, another79 HS codes were removed from the prohibitedlist. Interest rates on tariff payments made forthe domestic sales of bonded goods from theprocessing trade were also reduced from 6.12 percent to 0.36 per cent.Changes to export processing and relatedregulations impact Guangdong and the Pearl RiverDelta more than other parts of China given thatmore than two-thirds of China’s export processingfacilities are located in Guangdong Province.This means that the major impact of both theimposition and then removal of restrictions felldisproportionately on Guangdong. The key questiongoing forward is whether or when the restrictionswill be re-imposed.The Labour Contract LawChina’s Labour Contract Law came into effect on1 January 2008. The Law was created in orderto formalise working relationships, to reduce theexploitation of workers, to provide better balancebetween employers and employees, to encouragefurther upgrading of the workforce, and to promotebetter sharing of the fruits of China’s economicdevelopment. Many of the provisions mirror thosefound in several other countries around the world. 4139 In contrast, before the issuance of the new restrictioncatalogue, type A enterprises did not have to put upguarantee deposit even they carried out processing trade onthe blacklisted goods in the previous restriction catalogue.40 gbcode.tdctrade.com.41 See Ronald C. Brown, “China’s New Labor Contract Law”;Chris Devonshire-Ellis and Richard Hoffmann, “China’s laborlaw- The reality for overseas investors,” 18 January 2008; LianLian, “New Labor Contract Law of the PRC,” Shippers Today,Jan/Feb, 2008.

20One of the major provisions is that all employeesmust be given a written contract within 30 days ofemployment. The new Law allows for fixed termcontracts, open-ended contracts, and project-basedcontracts. Workers have to be offered an openendedcontract if they have been continuouslyemployed for 10 years or more, if they areemployed beyond two fixed period contracts,or if they have been working without a contractfor a year. The new Law contains a long list ofrestrictions on employer behaviour. These include aprohibition on coercion in general, on compellingovertime, on unlawful termination, on provisionof unsafe working environments, on excessiveovertime, among others. The Law provides forlayoffs to be explained to workers and unions andallows for layoffs only in cases where there aremajor difficulties or changes in the firm’s operation.Minimum severance pay is set at one month’ssalary per year employed up to a maximum of 12months’ salary. For employees with salaries abovethree times the local average salary, severance isset at three times the average monthly salary timesnumber of years worked up to a maximum of 12months’ payment.42 Circular on the Publishing of the Standard Contract ofGuangdong Province (Yue lao she[2007] no. 154), www.gd.lss.gov.cn.The Labour Contract Law enshrines an importantrole for labour unions. Unions are framed as therepresentative of workers for collective bargaining,termination cases, and other disputes. In specificsectors they are given the sole right to negotiatewith employers. The Law, in fact, sees a three-partsystem, with unions as full members along withthe employer and employee. Local governments ofDongguan, Guangzhou, Shenzhen, and Zhongshanhave published standard contracts to be used inthose cities. Firms in other cities use forms publishedby the Guangdong Provincial Government. Some ofthe articles in the Labour Contract Law are statedin the contracts as well: the standard working timeshall be no more than eight hours per day and 40hours per week; the largest amount of overtimework shall be no more than one hour per day ingeneral circumstances and no more than threehours per day or no more than 36 hours per monthin special circumstances. Workers are guaranteed atleast one day of rest a week. 42Overall, in the new Labour Contract Law, the rightsof workers have been enhanced, particularly whereit comes to abuses committed by employers. Thenew Law also makes temporary, seasonal, andcontract-based work more difficult and has a clearbias towards open-ended contracts. Employersbelieve that this will sharply reduce flexibility andincrease costs. Non-Chinese companies haveindicated that they believe that labour abuses orperceived labour abuses by non-Chinese firmsare more likely to be prosecuted than abuses byChinese firms, giving the latter a strong competitiveadvantage.Managers from Hong Kong companies interviewedfor the present project viewed the Law asparticularly problematic in that it makes seasonallabour fluctuations difficult to deal with, reducesthe amount of overtime that workers can do inspite of the fact that most workers prefer to dosignificant overtime, and makes it harder to hirecasual workers. The Law makes it more difficultto hire seasonal workers, which creates difficultiesfor industries with large seasonal fluctuations in

21demand and production (such as industries inwhich a large portion of sales are made for theChristmas period). The overtime limits were alsoviewed as problematic, since workers wanted towork more overtime to earn more money. Somemanagers indicated they knew of cases in whichcompanies offered unpaid voluntary work onSaturdays and then separately paid workers a bonusto compensate. It was reported that companies thatdid not engage in such practices could lose workersto companies that allowed the workers to effectivelywork more overtime and earn more money. Severalinterviewees claimed that companies that did notfind a way around some of the labour regulationsare at a competitive disadvantage versus Mainlandcompanies and others that ignore or stretch thelaw. Some interviewees wondered how theirown companies could survive alongside Chinesemanufacturing firms that operate in the same placeand compete in the same markets but have theability to avoid some costs or regulations. The Law isalso seen as compounding the problems of findingworkers and escalating wages that have hit thegarments, toys, and electronics sectors particularlyhard. 43Environmental and Safety RegulationsChina as a whole has suffered from significantenvironmental degradation associated with itsindustrial development. According to the WorldBank, China is home to 16 of the world’s 20 mostpolluted cities. The Pearl River Delta has also beenaffected by pollution. Guangdong has historicallybeen considered a laggard in environmentalprotection in China and several of its cities, mostnotably Dongguan, Foshan, and Guangzhou,have air quality that is poor even by Chinesestandards. In 2008, over 90 per cent of the citiesin Guangdong Province had an acid rain problem,and nine cities including Guangzhou, Shenzhen,Foshan, Jiangmen, Maoming, Zhaoqing, Huizhou,Dongguan, and Zhongshan, most of which arelocated in the PRD, are considered to be severelypolluted by acid rain. 44 In addition, in 2008, only 53per cent of Guangdong’s waste water was properlytreated. Efforts to address environmental concernsare improving in Guangdong, albeit slowly. In 2008,RMB 4.7 billion, or 1.4 per cent of fiscal revenuein the province was invested in environmentalprotection, compared to RMB 2.64 billion (0.95 percent of fiscal revenue) in 2007. 45In 2006, the Guangdong Government announced anEnvironmental Protection Initiative that targeted thechemical, petrochemical, smelting, electroplating,tanning, printing and dyeing, cement, papermaking,nuclear and radioactive, and hazardous wastetreatment industries. Environmental impactassessments were also expected to become tougheron polluting facilities. In 2006, 150,000 factoriesin Guangdong were inspected for pollution androughly 2,100 were closed down. 46 Guangdong hasset up strict guidelines for polluting industries tomove to “eco industrial parks” specially designedto accommodate and deal with effluents. Foshanhas been designated as an “environmentaldemonstration city”, while Dongguan is seeking thisstatus. In the first 10 months of 2006, Shenzhenofficials claimed to have refused permission orcaused to move from Bao’an District 1,260 firmsdue to environmental and energy consumptionconcerns. 47 In 2008, Dongguan officials claimed tohave shut down 173 factories that did not meetenvironmental standards, involving electroplating,printing and dyeing, paper making, and tanning.Additionally, more than 600 firms considered ashighly polluting were targeted for movement todesignated locations. 4843 ESA Project Interview, 2010-04-07.44 Gazette of Environment Situation in Guangdong Province2008.45 Guangdong Statistical Yearbook 2009, p.184. GuangdongEnvironmental Protection Bureau. www.gdepb.gov.cn.46 Ivan Zhai, “2,000 polluting factories shut down,” South ChinaMorning Post, 7 February 2007.47 “Shenzhen keeps 1,300 firms out of city,” China Daily, 29November 2006.48 “Dongguan Shut down 173 Highly Polluting Factories,”Guangdong Environmental Protection Bureau, May 28, 2008.www.gdepb.gov.cn.

22In preparing for the Asian Games to be held inGuangzhou in November 2010, the GuangdongGovernment has urged the PRD cities to tightenpollution control measures and announced thatfactories in the PRD might be forced to temporarilyshut down in October 2010 in the lead up to theGames. 49In November 2006, the Hong KongProductivity Council launched an initiative to helpHong Kong invested enterprises in the Pearl RiverDelta adopt cleaner production methods. Somefactories reduced harmful effluents by 30 per centor more within the first year of operation. In April2008, the Hong Kong Government launched a fiveyearCleaner Production Partnership Programme,with funding support of more than HK$93million by the Government, offering subsidiesto Hong Kong firms in the PRD for assessment,implementation, and certification of cleanproduction. The Hong Kong Productivity Councilis responsible for implementing the Programme incollaboration with other environmental technologyservice providers. By 31 December 2009, therewere 435 funding approvals issued and another 91applications were under review.49 “Guangdong Enhance Pollution Control for Asian Games,”Hong Kong Economic Times, 10 February 2010. www.hket.com.50 “PRD will restrict Cement, Ceramics, and Glass Industries,”Xinhuanet, 9 November 2009. finance.ifeng.co.51 “Enhancing Chemical Safety and Drug Value,” HongkongIndustrialist, July 2007.Specific industries that are considered pollutingand/ or energy intensive are being targeted forupgrading, relocation, and/ or closure in the PRD.The ceramics industry, for example, is viewedas labour-intensive and energy-consuming,and therefore inconsistent with the CentralGovernment’s new emphasis. The industry will notreceive preferential export policies or exemptionfrom environmental controls. Guangdong,which accounted for roughly half of China’sceramics exports will bear the brunt of the policychanges in the sector. In 2009, the GuangdongGovernment announced that it will further restrictthe development of the cement, ceramics, andglass industries in the PRD by shutting downor moving existing operations and limitingcapacity expansions. 50 Measures to support safemanagement in the chemical sector were extendedin 2006 and earlier guidelines began to beenforced. 51Relocating polluting industries has proven difficult.One such example is the electroplating industry.The Federation of Hong Kong Machinery and MetalIndustries estimated that there were about 300Hong Kong funded electroplating firms in the PRDin 2007 and that about 150 Hong Kong fundedelectroplating firms with a total of 10,000 workerswould be affected by the stringent environmentalpolicies. Three electroplating industrial parks havebeen approved by Guangdong’s EnvironmentalProtection Bureau for Jiangmen. The first, in Xinhui,is expected to start construction in October 2010 atthe earliest. The other two electroplating industrialparks in Jiangmen are still in the planning stage.

23In recent years, China has become more concernedabout product safety. The main focal point in thePearl River Delta region has been the toy industry.In 2007, 1,454 of the 1,725 toy factories inspectedin Guangdong were found to have safety flaws.Roughly 764 toy factories in Guangdong lost theirexport licences or had them suspended over productquality concerns and 690 were ordered to renovateplants and improve quality standards. A total of 774people were arrested. 52 Since Guangdong is thedominant toy producer in China, it was expectedthat the toy safety issues would hit the provincemore than other locations in China. In the firstquarter of 2009, EU announced 143 toy recalls,134 of which focused on products made in China.During the same period, US and Canada announced13 toy recalls, all of which involved products madein China. 53 In mid-2009, the EU and US enactedtheir new toy safety directive and toy safetystandards respectively, which made the situation fortoy exporters in Guangdong even more difficult.The garment and textile industry is another sectorwith increasing product safety concerns. In 2009,the EU announced 122 garment and textile recallsinvolving China-made products, a 184 per centincrease over 2008, and the US announced 33garment and textile recalls related to China-madeproducts, a 57 per cent increase over 2008. 54Environmental and product safety issues are likelyto have a disproportionate effect on the Pearl RiverDelta going forward. The Central Governmentseems intent on enforcing rules and regulationson export-oriented, foreign-invested facilities thatit considers as adding limited value to China’seconomy. At present the Pearl River Delta isdisproportionately represented in these industries.The Hong Kong manufacturing managersinterviewed for the present project indicated thatHong Kong firms had to follow all the relevantregulations and this put them at a competitivedisadvantage versus Mainland companies and othercompanies that do not. This led to expressed fearsthat the additional costs incurred in following theappropriate regulations might place some HongKong companies at such a disadvantage that theirviability could be under threat. To the Hong Kongmanagers, the issue frequently was not the natureof the rules and regulations, but rather the potentialfor asymmetric enforcement leading to competitivedisadvantages.52 “Guangdong toymakers lose export licenses,” ChinaEconomic Review, 2 November 2007. “764 toy factories inGuangdong hit with export ban,” The Standard, 2 November2007.44 Gazette of Environment Situation in GuangdongProvince 2008.53 HKTDC, “Analysis of Toy Recalls,” 18 June 2009.54 Hong Kong General Chamber of Textiles, “IncreasingRecalls of Mainland Textiles by US and EU,” 16 April 2010.textileschamber.org.

24Competitive EnvironmentThe competitive environment for Hong Kongmanufacturing SMEs in the PRD is changing inseveral ways. Hong Kong manufacturing firmsoperating in the PRD face increasing competitionfrom Mainland companies, either within the PRDor in other regions of China, such as the YRD,Shandong province, and other areas that are tryingto attract manufacturing companies. 55For the past 30 years, Hong Kong firms havetransferred the factories, management practices,culture, skills, and connections to China and havehelped companies and managers in Mainland Chinato improve their capabilities in communicationand their quality assurance systems. In addition,increasingly Chinese firms are hiring employeesfrom Hong Kong firms as well as consultantsfrom Singapore firms, Korean firms, and otherfirms where they think that this will support thedevelopment of their business. 56 As a result, thegap between Hong Kong firms and Chinese firmshas become smaller and Chinese firms are lesswilling to play a junior role to Hong Kong businessinterests. 57Many Mainland Chinese companiesthat once were partners or contractors to HongKong firms now have the skills, the technology, thecapital, the critical industry mass, the supply chain,the domestic market, the know-how, the contacts,and the government support to go it on their own.Consequently, the main competitors of many HongKong firms are Chinese companies, usually the spinoffsfounded by Chinese managers once hired andtrained by the Hong Kong companies. 58 It is difficultfor Hong Kong SMEs to avoid this phenomenon.55 ESA Project Interview, 2010-03-25.56 ESA Project Interview, 2010-04-09.57 ESA Project Interview, 2010-04-09.58 ESA Project Interview, 2010-04-07.59 ESA Project Interview, 2010-04-07.60 ESA Project Interview, 2010-04-07.61 ESA Project Interviews, 2010-04-07, 2010-04-09.62 ESA Project Interview, 2010-03-26.Since fewer Hong Kong people are interested ingoing into manufacturing, the Hong Kong firmsoften have to hire Mainlanders for managementpositions even if this practice can eventually createcompetitors. In addition, many Hong Kong firms setup supply or subcontractor relations with Mainlandfirms and this too can create competitors.To the extent that Mainland competitors are ableto run a less expensive operation than their HongKong counterparts, they can quote lower prices andwin business from Hong Kong companies. The costdifferentials are such that if Hong Kong companieshave even a few Hong Kong staff then this canalready provide a cost disadvantage that makesit difficult for the Hong Kong firms to competeagainst Mainland counterparts. 59Hong Kong manufacturing company managersinterviewed for this project indicated that Chinesefirms were viewed as being more competitivebecause of their ability to skirt the law withoutincurring penalties. According to the Hong Kongmanagers, Hong Kong companies need to followthe letter of the law and operate in a moreethical manner. As a result, some Hong Kongfirms have seen their profit margins eroded in theface of competition from Mainland companiesthat are viewed as not having to meet the samemanufacturing and business standards. 60Interviewees also indicated that Mainlandcompanies are often more forward-looking andaggressive than their Hong Kong counterparts.They are more likely to take risks and they alsohave more local resources in the form of local banksupport, “free capital,” or government support. 61Several interviewees for the present study indicatedthat indigenous Chinese firms learn very fastto “play the game,” making them formidablecompetitors. 62 Mainland company owners are seenas being increasingly knowledgeable and capable,close to the ground, and closer to local officials.They are also often willing to put up with very lowmanufacturing margins, and will engage in practicessuch as copying the designs of other companies to

25keep costs down rather than investing in developingtheir own designs. On the other hand, intervieweesviewed Hong Kong firms and Hong Kong managersas more conservative and less connected. Forinstance, the senior management of Hong Kongfirms tend to live in Hong Kong rather thanMainland China and they do not commit sufficientlyto learning about China to maximise their abilityto leverage Chinese manufacturing or develop theChina market. 63Chinese Mainland Policies AffectingOperations in the Pearl River DeltaEconomic and industrial policies within the ChineseMainland, particularly those focused on GuangdongProvince and the Pearl River Delta, have a criticalimpact on Hong Kong manufacturing SMEs. Ofparticular note have been policies for economicrestructuring in the PRD, the NDRC Plan for theReform and Development of the Pearl River Delta,and the Hong Kong-Guangdong CooperationFramework Agreement.Policies for Economic Restructuring in the PearlRiver DeltaEconomic policies and plans for the Pearl RiverDelta will have a dramatic impact on Hong Kongmanufacturing SMEs that operate in the region.China’s 11 th Five Year Programme (2006-2010)reflected the Central Government’s view thatthe nation’s development needed to be adjustedto emphasise the quality of growth, reduceregional imbalances, reduce speculation in theproperty market, improve the environment, reducedependence on low value-added production, andimprove the position of workers. GuangdongProvince and the Pearl River Delta region werechosen to play a leading role in innovation,knowledge, and creativity-based economicdevelopment in China. This national role includedchannelling technology, funds, and know-how intoChina’s interior; acting as a base for foreign privateinvestment into China’s interior; and fostering thedevelopment of modern service sectors on par withthose found in advanced economies.Another goal was to move labour-intensive, lowvalue-added, and/or polluting industries out of theinner areas of the Pearl River Delta into other partsof the region, other parts of Guangdong, or otherparts of the country. One sign of how seriously thenew directions have been taken is the fact that theCentral Government has designated specific citiesin interior provinces that it hopes will become thehomes of some of the industries moved out ofthe Pearl River Delta (and Yangtze River Delta aswell). These include Chenzhou (in Hunan Province),Wuhan (Hubei), Xinxiang and Jiaozuo (Henan), Hefeiand Wuhu (Anhui), Taiyuan (Shanxi), Nanchang andGanzhou (Jiangxi), and another 22 cities.However, in the newly published policies by theState Council on using foreign capital, 64 highlypolluting, high energy-consumption, and resourceintensiveprojects, as well as projects in industriesrunning at overcapacity, will be strictly restrained allover China. Foreign-funded enterprises are offeredincome tax breaks to increase their investment inChina’s central and western regions, particularly ineco-friendly and labour-intensive companies.63 ESA Project Interview, 2010-04-07.64 Several Opinions of the State Council on Further Fulfilling theWork of Using Foreign Capital (Guo fa [2010] no. 9), 6 April2010.

26Guangdong Province’s priorities in implementingChina’s 11 th Five Year Programme were set outby Guangdong Governor Huang Huahua in theprovince’s 2008 Work Report. 65They includedfostering indigenous innovation, branding, andintellectual property creation; developing modernservice and high-technology industries; reformingtraditional industries; improving the sophistication ofmanufacturing; boosting infrastructure investment;and fostering industry clusters and large-scale localfirms. Emphasis also was placed on increasingrural investment and enhancing rural services;reducing energy consumption and pollution; andstrengthening domestic demand. Foreign trade andinvestment would be directed towards restructuringthe economy, and ways would be sought to extenddevelopment beyond the Pearl River Delta regionand to further cooperation with Hong Kong andMacao while building linkages with Pan-Pearl RiverDelta provinces. In addition, at the Second PlenarySession of the 10 th Guangdong Party Committee inJanuary, Wang Yang, Communist Party Secretaryfor Guangdong Province, emphasised the needfor Guangdong to adopt a global vision for itsdevelopment in order to maintain its leadershipwithin China. This is due to China’s increasinglinkages with the rest of the world, its strongposition in international trade and investment,China’s position as a recent member of the WorldTrade Organisation, and Guangdong’s history as anoutward looking part of the country. 6665 Huang Huahua, “Guangdong Government Work Report,”17 January 2008.66 “Plan Guangdong’s development with a ‘global vision’,”3 March 2008. www.newsgd.com.NDRC Plan for the Reform and Development ofthe Pearl River DeltaIn November 2008, the National Developmentand Reform Commission (NDRC) issued the “TheOutline Plan for the Reform and Development ofthe Pearl River Delta (2008-2020)”. The NDRC Plan,designed to provide a roadmap for the region’sdevelopment, called for greater autonomy ineconomic decision-making, the acceleration ofinfrastructure construction, greater openness, closereconomic linkages with Hong Kong and Macao,and the creation of world class bases for modernmanufacturing and service industries.The NDRC Plan called for stable and fast growth,growth in consumer demand, improved livingconditions, upgraded industrial structure, moreindependent innovation, improvements in theenvironment, social security coverage for bothurban and rural areas, and universal availabilityof public services. In terms of industrial policies,the focus will be on modern services and hightechnologyindustries, innovation in coretechnologies and consolidating the role ofenterprises in innovation. Priority also will begiven to modernising infrastructure, optimisingthe geographic distribution of economic activitiesaround the PRD, enhancing regional economicintegration across the entire Pearl River Deltaregion, and encouraging accelerated developmentof areas surrounding the region. The Plan callsfor closer cooperation with Hong Kong andMacao, closer cooperation with Taiwan, deepercooperation with the Pan-Pearl River Deltaregion, and enhanced cooperation with ASEANand other international economic regions. ThePlan also focuses on resource conservation andenvironmental protection, upgrading socialservices, and institutional reform.While much of the NDRC Plan repeated earlierprogrammes and policies, there are a number ofnew or newly emphasised points. These include theindication that more autonomy will be given to theregion, the emphasis on the service sector, the focuson building strong firms, commitments to several

27specific infrastructure projects, a commitment tobuild dual city integrated sub-regions (Guangzhou-Foshan, Shenzhen-Hong Kong, and Zhuhai-Macao),a commitment to build over 100 research centresin the region, placing environmental issues at thecore of Pearl River Delta development, and directstatements about the administrative improvementsneeded in the region.In 2009, Guangdong Governor Huang Huahuareaffirmed that “Despite the challenges from thefinancial crisis, Guangdong will unswervingly followthe opening up policy, continue the economicreforms and realise the Outline of the Plan forReform and Development in the PRD”. 67TheGuangdong Government’s 2010 Work Report issuedin January of that year indicated that implementing“The Outline Plan for the Reform and Developmentof the Pearl River Delta” would be its first priority.Areas of emphasis include promoting independentinnovation; transforming and upgrading traditionalindustries; establishing a modern industrial system;maintaining stable and relatively fast economicgrowth; vigorously expanding domestic demand;promoting balanced development among regions;accelerating institutional reform and opening-up;and strengthening the social system with a focus onsocietal well-being. 68Numerous specific programmes were mapped outin the main text of the Agreement. One of thestriking features of the Agreement was that whileit contained extensive discussion of Hong Kongservice industries and how these could supportdevelopment in Guangdong, it contained far lessmaterial on Hong Kong manufacturing industriesand firms.In the main text of Agreement, the fourth chapteris “Manufacturing industries and innovationand technology.” On these aspects, Hong Kongand Guangdong are to fully develop individualadvantages and jointly accommodate the globalindustrial transfer, improve innovation capability,push up the transformation and upgrade oftraditional manufacturing industries, and cultivatestrategic emerging industries, and thus to buildan advance manufacturing basis with corecompetitiveness in the world.67 Remarks by Governor Huang Huahua at the Press Conferenceof the ICCFED 2009, www.iccfed.gd.gov.cn.68 Guangdong Government Work Report 2010.The Hong Kong-Guangdong CooperationFramework AgreementThe Hong Kong-Guangdong CooperationFramework Agreement signed in April 2010 wasan important step in implementing the cooperationcalled for in the NDRC document. The overallthrust of the Agreement was to enhance the jointdevelopment of Hong Kong and Guangdong,enhance Hong Kong’s position as a financial centre,capitalise on the competitiveness of Hong Kong’sservice industries and Guangdong’s manufacturingindustries, facilitate the flow of key factors acrossthe boundary, implement a regional environmentalregime, and promote the cooperative developmentof Hong Kong and the cities of Guangdong into aworld-class metropolitan cluster.

28One important area of cooperation is on therestructuring and upgrading of the exportprocessing trade. The Agreement calls on HongKong and Guangdong to engage in:i assisting Hong Kong-owned processingenterprises to extend their production chain,encourage them to establish research sections,improve innovation capability, build their ownbrands, and increase value-added.ii supporting Hong Kong-invested enterprises inopening up the Mainland domestic market andbuild brands in the domestic markets.iii encouraging Guangdong and Hong Konginvestors to participate the construction ofrecycling industrial parks and industrial relocationparks in the development zones designatedby the nation. Promote Hong Kong-investedenterprises to invest in Guangdong’s industrialrelocation parks if these enterprises have suchneeds.The major initiatives on manufacturing industries for2010 include:i The two places will carry out the policies thatpromote the development of manufacturingindustries, including Direction of GuangdongProvince for the Operation of Original PremiseTransformation of Enterprises Engaged inProcessing with Supplied Materials withoutProduction Suspension, and Guiding Opinionof Guangdong Province on the Work ofPromoting Foreign Invested and Processing TradeEnterprises to Expand Domestic Sales. Fulfillingthe Cooperation Agreement of Guangdong andHong Kong on Promoting the Conversion andUpgrading of Hong Kong-invested ProcessingTrade Enterprises.69 Opinions on Promoting the Stable and HealthyDevelopment of SMEs (Yue fu [2008] no. 104)70 Circular on Several Policies and Measures of Guangdongto Support Hong Kong, Macau, and Taiwan-investedEnterprises to Combat the International Financial Crisis toSpeed up Conversion and Upgrading (Yue fu ban [2009]no. 3, 16 January 2009)ii Guangdong will hold the Guangdong Expositionof Products by Foreign-invested Enterprises (forDomestic Sales) to facilitate foreign-investedenterprises in Guangdong to build connectionsand cooperate with purchasing groups,commercial circulation enterprises, and retailersto expand into domestic markets.In addition, the Agreement called for Hong Kongand Guangdong to pioneer the introductionof electric vehicles to Hong Kong, Guangzhou,Shenzhen, and others and to foster the research anddevelopment, manufacturing, general applicationand development of the auto parts industry forelectric cars in the Greater PRD Region.Guangdong Initiatives for SMEs in Response tothe Economic CrisisSince the onset of the financial crisis, GuangdongProvince has also instituted a series of policiesto support SMEs. On 2 December 2008, theGuangdong Government issued the “Opinions onPromoting the Stable and Healthy Developmentof SMEs” (Yue fu [2008] no. 104) in an attemptto ease the financing difficulties of SMEs and tostrengthen fiscal and tax support for SMEs. In 2009,the Guangdong Government started to arrangeRMB 2.2 billion to subsidise technology upgradesand innovation by SMEs, to expand the exportcapabilities of SMEs, and to provide other servicesand support for SMEs. 69In January 2009, the Guangdong Governmentpublished policies aimed at helping SMEs fundedby investors from Hong Kong, Macao, and Taiwancombat the financial crisis. 70These includedincreased fiscal support; reductions or exemptionsfrom taxes and fees; simplified administrativeprocedures; support for independent innovation;ensuring supplies of water, electricity, and naturalgas; and support for labour training efforts. Acommitment was also made to try to secure CentralGovernment support for policies to support HongKong, Macao, and Taiwan invested SMEs. In April2009, Guangdong outlined a series of measuresintended to help SMEs expand into domestic

29markets. 71This included helping SMEs to jointhe marketing networks of leading enterprises,making use of Guangdong commercial associationsto provide SMEs with greater access to nationalmarketing networks, to provide special funds forSMEs that have national “famous products,” and tosupport SMEs to help them develop products andservices that are suitable for China’s rural markets.In January 2010, the Guangdong Governmentinstituted a strategy to help SMEs expand domesticsales and develop advanced manufacturingcapabilities. 72In March 2010, the GuangdongGovernment published a policy to further supportthe development of SMEs by unifying market entrystandards and opening the market for privateenterprises to industries with high profit, such aspower, telecommunication, petrochemicals, andfinance. 73Perspectives on the Direction of Policy for thePRDThe most striking feature of the NDRC documentis that it starts with a short description of thesuccess of the PRD and its development over thelast 30 years and then has a much longer sectionderiding the development model that generatedthis success in the first place. The PRD pastdevelopment model is criticised as being low-valueadding, low-technology, labour-intensive, resourceintensive,overly dependent on exports and foreigncompanies, and environmentally and sociallyunsound. The rest of the document outlines anapproach for a radically different economic modelgeared more to replace the previous model than tobuild on and extend its successes.has been quoted as saying that it is time for“emptying the cage for new birds to come in.” Thiswould involve letting go or pushing out many of theHong Kong and Taiwan invested SMEs that havebeen lynchpins of Guangdong’s development sincethe 1970s. 74While aiming to combat the financial crisis, it isclear that the Guangdong Government remainscommitted to its plans for industrial restructuringand upgrading. A trial of programmes for thetransformation and upgrading of export processingenterprises was begun in Dongguan in 2008. InApril 2010, the programme was extended to therest of the PRD with the exception of Jiangmen. 75These cities will promote processing tradeenterprises to make breakthroughs in independentinnovation, indigenous brand development, researchand development, domestic market penetration,establishing and improving marketing networks,and industrial upgrading.71 Opinions on Helping SMEs to Expand into Domestic Markets(Yue jingmao zhongxiao ju [2009] no.326, 23 April 2009)72 Decision of Guangdong Provincial Party Committee andGovernment on Implementing the Strategy of ExpandingDomestic Demand (published on 15 January 2010)73 Opinions on the Implementation of Opinions of the StateCouncil on Further Promoting the Development of Small andMedium Enterprises (Yue fu [2010] no. 39, 25 March 2010)74 Cong Cao, “Emptying the cage for new birds to come in,”UPI Asia, 17 February 2009.75 Circular on the List of Key Cities to Deal with theTransformation and Upgrading of Processing TradeEnterprises (Yue ban han [2010] no. 198, 12 April 2010).The NDRC document and the subsequentdiscussions on PRD development give a mixedmessage to Hong Kong and its firms. On theone hand, further cooperation and interactionwith Hong Kong is viewed as important for thePRD development. On the other hand, the policydirection appears to provide little space for HongKong manufacturing SMEs in traditional industries.Indeed, Guangdong’s Party Secretary Wang Yang

30According to the Hong Kong manufacturingcompany managers interviewed for this study,it is clear that the emphasis in Guangdong willbe on high-technology manufacturing and highendservices at the expense of more traditionalindustries. According to the interviewees, 10years ago the Guangdong Government wasaccommodating to traditional industries but notanymore, and these industries are viewed as beingon the way out. 76 Industries that are consideredto be highly polluting, highly energy consuming,resource-intensive, and low value-added are all outof favour. For many Hong Kong companies, onetrouble is that the Guangdong Government seemsto view sectors as either “good” or “bad” in theirentirety, not necessarily taking into account whethera specific company uses advanced technology,advanced design, or green production techniques.Another problem is that industries do not exist inisolation. Instead, they exist in entire productionchains. Singling out a single industry to be movedor closed down can therefore influence an entireproduction chain. The dyeing industry, for example,has been targeted as a polluting industry, butwithout dyeing the entire garment productionchain may be at risk. Similarly, electroplating hasbeen targeted as a polluting industry, but withoutaccess to electroplating, the electronics and otherproduction chains are at risk. 77Guangdong isthe home of many industry clusters with nearlycomplete supply chains, if individual sectors aremoved too quickly then the entire supply chain canbe disrupted. The success of the PRD manufacturershas to do with the presence of complete supplychains, but many interviewees believe that policiesin the Chinese Mainland appear not to be madewith this fact in mind. All Chinese jurisdictionswant high-end of manufacturing, but many do not76 ESA Project Interview, 2010-04-07.77 ESA Project Interview, 2010-05-03.78 ESA Project Interview, 2010-03-24.79 ESA Project Interview, 2010-04-07.adequately provide for the right types of support tobe put in place to accompany changes to the profileof industry. 78 This is why industry is slow to move tolocations such as Indonesia that can provide 30 percent to 40 per cent savings on wages and land. Fewcompanies have moved there due to the lack ofsupply chain that supports their broader needs. 79In any case, the upshot of the policy directionsin the PRD for Hong Kong manufacturing SMEsand firms from other jurisdictions is that the firmswill be welcome as long as they contribute to thedevelopment of a new-type of economy in thePRD, but less welcome if they follow traditionalmodels or operate in traditional industries. Thuswhile providing some opportunities for Hong Kongmanufacturing SMEs that can participate in theupgrading initiatives and develop the capabilitiesto contribute to the desired innovation capabilitiesof the PRD, the direction calls into question thecontinued viability of the vast majority of HongKong manufacturing SMEs operating in the PRDthat cannot make this type of contribution.Operational and Strategic IssuesThe present project has identified a number ofoperational and strategic issues that affect theperformance of Hong Kong manufacturing SMEs.Shortcomings in the Business BasicsMany Hong Kong SMEs are managed in a fairlyhaphazard fashion. Few SME managers haveformal business training. Few have developedreal business plans. Few have developed creativestrategies. Few have committed to researchingmarkets, understanding precisely evolving customerrequirements, and finding new ways to serve thecustomer. Few use modern accounting, informationtechnology, inventory management, or businessprocess tools. As a result, many leave money onthe table due to internal inefficiencies. While suchfirms may get by in good times, increasingly thecombination of tough global markets, powerfulcustomers, and capable competitors makesinefficiency unsustainable.

31Failure to DifferentiateMany Hong Kong SMEs have not identified aspecific niche and differentiated themselves tothe extent that customers view them as havingsomething unique and valuable. The absence ofdifferentiation leaves a company open to pureprice competition and to customers constantlydemanding lower and lower prices regardlessof costs. The key to differentiation is to identifyspecific customer requirements and then meetthose requirements better than the competitors.If successful, such differentiation usually leads toat least a limited amount of pricing power, whichprovides some insulation against difficult economictimes. Many Hong Kong companies have yet todevelop truly distinguishing capabilities. As a result,they are vulnerable to competition from other HongKong companies as well as those from the ChineseMainland.Limited Scope of ManagementMany Hong Kong SMEs have a limited scope ofmanagement in terms of numbers, geographicscope, activity scope, and market scope. HongKong SMEs generally have one or a small numberof senior managers that are the driving forces of thecompany. A small number of managers means thatthe companies suffer significantly when new rules,regulations, and administrative requirements comeinto effect. In geographic terms, many Hong KongSMEs appear to be able to manage within HongKong and perhaps in certain cities in Guangdong,but have a hard time managing activities elsewhere.This limits their ability to react to rising costs andshifting policies, and limits their potential to takeadvantage of newly emerging manufacturinglocations elsewhere in China, elsewhere in EastAsia, or elsewhere in the world. In many cases,Hong Kong SME managers that have operated inGuangdong for many years still do not really knowGuangdong, the local officials, the local suppliers,and the local competitors nearly as well as newlyemerging Chinese counterparts. While this maynot have been an issue when there were relativelyfew capable Mainland Chinese managers andcompanies, it is less and less the case.In terms of activity scope, many Hong KongSME managers are comfortable producing forOEM customers that provide the orders and thespecifications, and then distribute the products.Far fewer Hong Kong SMEs are comfortabledeveloping their own designs, getting their ownorders in overseas markets, and then distributinginternationally. This of course limits the scope ofwhat they can do in good times or bad. Finally, asrelatively few Hong Kong SMEs have engaged insignificant market development, they are reliant onothers to carry out this process. This means thatmany SMEs are not in regular contact with endcustomers and therefore have a more difficult timeanticipating or leading industry trends.Gaps in SuccessionMany Hong Kong’s manufacturing companieswere founded in the 1980s or earlier and rapidlyexpanded with the growth in South China in the1990s. In many cases, the founder or proprietor isnearing retirement age with no apparent successor.In some cases, there are no children that can takeover. In other cases, the children are pursuing otherinterests, or careers in industries that are consideredmore prestigious and less difficult, and do not wishto take over. Since the vast majority of Hong KongSMEs are family firms with members of the familyas managers, this creates a difficult situation. Withno obvious successors and with difficulty in sellinga company that has often been built around asingle individual, for many SME owners there is noclear exit strategy. The risk is that otherwise strongcompanies with good franchises may fall on hardtimes and cease to contribute to Hong Kong and toSouth China.

32Difficulty in Finding Capable ManagersMany Hong Kong manufacturing SMEs are findingit increasingly difficult to find capable managersfor their operations. Most would like to rely onmanagers from Hong Kong who understandthe processes as well as the business side of theoperations. However, several interviewees indicatedthat Hong Kong people are not going into themanufacturing sector nearly as much as in the past.Instead, they are going into the financial service,professional service, or property sectors. Theresult is that the group of Hong Kong managerscapable of managing manufacturing operationsis aging and shrinking. The solution for manycompanies is to try to source managers from theChinese Mainland, where 30 years of economicreform and development is generating a group ofcapable managers. Unfortunately, this group is alsoin demand from major multinational companiesand growing Chinese companies too. In addition,developing a strong group of managers from theChinese Mainland is viewed as potentially creatingfuture competitors should these managers use theknowledge they have gained to shift to a competitoror to open their own company and engage in directcompetition with their former employer. SomeHong Kong companies source managers fromTaiwan, Singapore, Korea, or elsewhere, but find itcan be difficult to integrate several different cultureswithin a small firm.Difficulty in Obtaining FinanceWhile by their nature SMEs do not require hugeamounts of financing, on the other hand SMEsoften find it difficult to find the financing that they80 See Federation of Hong Kong Industries, “Survey Reporton SMEs Credit Status,” (Chinese version only), October2008.do need. Personal and family capital is often usedfor start-up, but working capital and financing foroperational needs often must come from othersources. Banks are the usual sources of financing,but SME managers report that relatively few bankstruly understand the SME operations. Even thosethat do tend to require personal guarantees andpledges of private assets for loans to the SMEs.Reliance on bank capital can create difficulties intimes of economic hardship. In an October 2008survey carried out by the Federation of Hong KongIndustries, one in 10 responding SMEs reportedthat their credit quota had been cancelled by theirbanks and a majority of respondents indicated thattheir credit terms with banks had been adverselyaffected. Although 80 per cent of the enterprisesreported that they were still financially sound, theythought that if banks further cut off their credit andthe external environment further worsened, theywould face difficulties. 80Lack of Knowledge of Support ProgrammesThe Hong Kong Government and related agenciesoffer a wide range of support programmes for HongKong’s SMEs. The unfortunate fact appears to bethat relatively few of the SMEs these programmesare designed to help actually know of theirexistence. As a result, the take up rate is rather lowand the results not as strong as one might hope.Perspectives on Operational and StrategicIssuesAll over the world, the vast majority of SMEs thatare started eventually fail. The most commonreasons for failure are not changes in externalmarkets, or changes in public policies, or even theemergence of new competitors. The most commonreasons for failure involve basic flaws in the businessplan (or the lack of a business plan), basic flaws inoperations, and basic flaws in management. Thuswhile Hong Kong SMEs need to understand andadjust to global economic conditions, changingconditions in China, and a changing competitivelandscape, they also need to ensure that they getthe basics right in order to survive and thrive.

33The Impacts of Developments on Hong KongManufacturing FirmsThere have been a number of reports of impacts ofthe developments in the Pearl River Delta on HongKong firms in recent years. These reports highlightthe challenges faced by Hong Kong manufacturingSMEs operating in the Pearl River Delta region.Greater PRD Business Council/ HongKong Trade Development Council(June 2007) 81According to a June 2007 report prepared for theGreater Pearl River Delta Business Council by theHong Kong Trade Development Council on theimpact of changes in export processing regulations,as of 2006 there were 57,500 Hong Kong investedfactories controlled by 55,200 companies in thePearl River Delta region with 9.6 million employees.In 2006, 80.7 per cent of Hong Kong’s re-exportsof Mainland China origin were related to exportprocessing. 82Based on a survey conducted in early 2007, theHong Kong Trade Development Council concludedthat 14,500 Hong Kong enterprises would beseriously affected due to the changes of processingtrade policy of adjustment of the tax rebate ratesand issuance of the new restriction cataloguefor processing trade. The survey concluded that1,500 enterprises could cease production, 375,000Mainland production workers (out of 9.6 millionemployed by Hong Kong firms) could lose theirjobs, and 10,000 employees in Hong Kong couldlose their jobs. If these impacts were to cascadethrough the economy a total of 10,000 enterprisescould cease or scale down production, 2.5 millionmainland production worker jobs could be underthreat, and a total of 70,000 Hong Kong jobs couldbe in jeopardy. The report noted that Hong Kongmanufacturers had already reported a drop of profitmargins in export processing of 18 per cent in 2002to 10 per cent in 2007.In terms of factors that were affecting theinvestment environment in the PRD, Hong Kongcompanies listed rising labour costs and labourshortages of skilled workers, RMB appreciation,rising land costs and restrictions, and tighteningof processing trade policies as the factors mostaffecting the investment environment (see Exhibit12). It should be noted that the final details of theLabour Contract Law were announced after thesurvey period, though the outlines of the Law hadbeen released earlier.81 GPRD Business Council, “Implications of Mainland ProcessingTrade Policy on Hong Kong,” June 2007.82 These numbers include both direct investment enterprisesand companies in other contractual forms. Other contractualforms include three forms of processing and assemblyoperations, compensatory trade, and any other processingarrangements or relationships into which a foreign companyenters with a Mainland factory.Exhibit 12. Factors Affecting the Investment Environment in the PRD, 2007WeightedAverage ScoreEvaluation (%)1 = Most Impact, 5 = Least Impact, No = No Impact1 2 3 4 5 NoRising labour cost/ skilled labour shortage 1.78 56.2 22.9 11.2 4.4 3.9 1.4RMB appreciation 1.96 43.9 26.8 17.3 6.1 4.4 1.5Rising land cost/ land restrictions 2.21 25.4 19.8 25.5 11.2 6.9 11.2Tightening of processing trade policy 2.22 26.9 21.4 25.5 9.9 7.2 9.1Tightening of Labour Contract Law 2.27 24.6 28.4 29.5 7.9 5.1 4.5Power/ water shortage 2.33 25.0 23.2 27.2 11.4 6.8 6.3Adjustment in export VAT rebate 2.37 19.2 21.9 26.7 12.4 8.8 11.0Higher environmental protection requirements 2.37 21.8 26.8 28.3 10.8 6.6 5.6Expiry of corporate income tax concession 2.39 20.2 22.7 29.0 12.3 7.5 8.3Note: According to Hong Kong Manufacturers.Source: Hong Kong Trade Development Council.

34Hong Kong Trade DevelopmentCouncil (November 2007) 83In November 2007, the Hong Kong TradeDevelopment Council surveyed Hong Kong firmsoperating export processing facilities in the PRDon the impact of changes in export processingand environmental regulations. A total of 75.1 percent of respondents indicated that their exportprocessing operations had been affected by thechanges in export processing rules instituted in2007 and 24.9 per cent indicated their operationshad not been affected. A total of 44.5 per centindicated that the changes had led to an increasein input costs; 30 per cent had to pay customsduty deposits on inputs; and 25.2 per cent saw animpact on the availability of inputs from suppliers(note that some companies cited multiple effects).Despite the impacts, 78.3 per cent of the firmsindicated that they would not consider relocatingtheir operations from the PRD. The main reasonsthat were cited for this lack of interest in relocatingout of the PRD were cost of relocation (40.9 percent), their PRD business is still profitable (19.3per cent), they were not aware of other options(17.5 per cent), relocation to another region wouldweaken firm competitiveness (16.6 per cent), andothers (10.4 per cent).83 See Hong Kong Trade Development Council, “LatestDevelopment and Strategies of Hong Kong Companies”Processing Trade Business in the Pearl River Delta- SurveyFindings,” 30 January 2008.Overall, the outlook of the Hong Kong companieswas mixed. In the short-term (one to two years),more respondents felt their business would seerapid decline (7.4 per cent) than rapid growth (4.8per cent). On the other hand, more respondentsbelieved their operations would have moderategrowth (34.2 per cent) than moderate decline (28per cent). Similarly, on a three to five year timescale, more respondents believed export processingbusiness would rapidly decline (15.1 per cent)than rapidly grow (7.1 per cent). Slightly morerespondents believed their operations would exhibitmoderate growth (33.5 per cent) than moderatedecline (31.5 per cent) (see Exhibit 13).Exhibit 13. Outlook for the Business of HongKong Export Processors, November 2007ProspectsShort-term(1-2 years)% of RespondentsMedium-term(3-5 years)% of RespondentsRapid growth 4.8 7.1Moderate growth 34.2 33.5Unchanged 25.6 12.8Moderate decline 28.0 31.5Rapid decline 7.4 15.1Source: Hong Kong Trade Development Council.Many of the respondents indicated their companieswere taking action to maintain or expand theirbusiness in the PRD. A total of 42.4 per centindicated that they would look to increase sales inChina’s domestic market (presumably foregoingthe tariff breaks afforded to export processingproduction); 42.1 per cent were looking to increasedomestic sourcing of inputs (so they would not haveto pay import tariffs on the inputs); 34.7 per centwould consider changing from an export-processingoperation to a foreign-invested enterprise (therebyforegoing the advantages of export processingwhile also avoiding the restrictions associated withexport processing); 22.8 per cent indicated that theywould increase capital investment (presumably toautomate production and to improve environmentalperformance); and 16.3 per cent would investin green production (to improve environmental

35performance). Note that the figures add to morethan 100 per cent because some firms wereundertaking more than one initiative.The Trade Development Council indicated that inthe face of shrinking profit margins among theHong Kong export processing companies, that totalcost increases on the order of six per cent to 12 percent due to labour cost increases, RMB appreciationand other cost increases could put many of thefirms in peril. What they did not report were thatmany companies had been able to raise exportprices three per cent to four per cent per year in thelast two years and that average re-export marginsfor goods taken from the Chinese Mainland toHong Kong and then re-exported from Hong Kongwere on the order of 25 per cent to 30 per cent, 84implying that many Hong Kong invested enterpriseshad far more staying power than the survey resultsmight indicate.Hong Kong Trade DevelopmentCouncil (February 2008) 85I n F e b r u a r y 2 0 0 8 , t h e H o n g K o n g T r a d eDevelopment Council released a report entitled“Offshore Trade and Production: Developmentand Implications.” The report used data obtainedfrom a survey undertaken in 2007. While the mainthrust of the report was on modes of trade, it alsoinvestigated production conditions in the Pearl RiverDelta.According to the report, 91 per cent of respondingcompanies produced or sourced goods in theChinese Mainland. Of these, 59 per cent had orsourced production only in Guangdong, 30.5 percent in Guangdong and other parts of China, and10.5 per cent only in other parts of China. Only24.8 per cent of respondents reported that theircompanies were selling to the Chinese Mainland,but another 50.9 per cent indicated that theyplanned to do so in the next three years. The lowestratios of sales into the 44 per cent of the respondingcompanies (manufacturing and trading companieswere surveyed and 52 per cent of respondents weretrading companies) had production operations inthe PRD. These companies identified rising labourcosts/ lack of skilled labour as the major problemsin manufacturing in the PRD, trailed by RMBappreciation, rising land costs/ restrictions on landuse, tightening policies on outward processingtrade, and expected tightening of the LabourContract Law. When asked what strategies theywould take to tackle these problems, 53 per centsaid they would develop better quality products,while 45 per cent said they would enhance productdesign and innovation, and 37 per cent indicatedthey would relocate PRD production.Exhibit 14. Strategies of Hong KongCompanies for Tackling the Problems inManufacturing in the PRD, First Quarter 2007Strategies% ofRespondentsDevelop better quality products 53.1Enhance product design and innovation 45.1Relocate existing PRD production to otherplaces37.3Improve efficiency by better inventory control 36.7Automate the production process to lowerwage costs35.9Develop own brand products 35.0Shift registration from “outward processing” to“wholly owned” or “joint venture”24.6Develop related products in other industries 22.7Implement green manufacturing system 18.0Invest in high-tech product development 17.8Give up manufacturing and focus on sourcingand marketing12.2Take no action 8.7Source: Hong Kong Trade Development Council.84 Enright, Scott & Associates Ltd. estimate85 See Hong Kong Trade Development Council, “OffshoreTrade and Production: Development and Implications,”5 February 2008.

36Among the respondents with a relocation plan,37 per cent said they would move their existingproduction in the PRD to pan-PRD provinces otherthan Guangdong, 34 per cent to other Guangdongareas outside the PRD, 21 per cent to YRD, and sixper cent to rest of the Mainland. The remainingthree per cent even considered to move outside theMainland.Even with a substantial number of companiesplanning some relocation of production or sourcing,only 8.3 per cent of respondents indicated that theircompanies would decrease overall managementand planning in Hong Kong while 27.2 per centindicated they would increase it. The projected“increases in Hong Kong” also outweighed theprojected “decreases in Hong Kong” for financeand accounting, product design and development,sales and marketing, quality control, and tradefinance and insurance. The projected “decreases inHong Kong” outweighed the “increases” in humanresources, purchasing raw materials, manufacturing,production management, arrangement of logistics,and trade documentation.86 Federation of Hong Kong Industries, “PRD BusinessEnvironment Survey,” March 2008.Federation of Hong Kong Industries(March 2008) 86According to a March 2008 report of theFederation of Hong Kong Industries, the businessenvironment for members operating in the PearlRiver Delta had undergone changes related toexport processing regulations, the Labour ContractLaw, the appreciation of the RMB, inflation inChina, and rising material prices. The firms ratedthe Labour Contract Law as providing them withthe most difficulty, followed by appreciation of theRMB, changes in export processing rules, labourshortages, and shortages in utilities.In terms of impact on costs, 84 per cent ofrespondents indicated that RMB appreciation hadresulted in a five per cent to 10 per cent increasein costs in the previous two years (see Exhibit 15).The vast majority of respondents (75.3 per cent)indicated that the impact of inflation from 2007to 2008 had resulted in an increase of five percent or more (40.7 per cent indicated more than10 per cent). More than half (51.2 per cent) of therespondents indicated that the new Labour Lawwould result in a rise in costs of above 10 per cent.Around 30 per cent of respondents had experiencedlabour disputes in the first two months of operationof the Labour Contract Law.Exhibit 15. Estimated Cost Impact on PRD Operations, Percentage of Respondents, 2008Estimated ImpactRMB Appreciation(2006 to 2008)Inflation(2007 to 2008)Labour Contract Law(2007 to 2008)No obvious impact 1.9 1.2 2.5Total Impact(2007 to 2008)Rise in cost around 1-5% 13.6 23.5 16.7 5.6Rise in cost around 5-10% 84.0 34.6 28.4 22.4Rise in cost above 10%40.7 (average risearound 17.2%)51.2 (average risearound 21.8%)70.2 (average risearound 20.5%)No comment 0.5 1.2 1.8Source: Federation of Hong Kong Industries.

37The RMB appreciation and inflation figures wereconsistent with reported movements in theseareas, while the Labour Contract Law figures wereconsistent with the expense of setting up moreformal labour systems and adjusting for severancepayments and loss of flexibility under the newlaw. It should be noted, however, that the valueadded in typical export industries in Guangdongis on the order of 25 per cent to 40 per cent, andtherefore the increases in individual elements do notnecessarily correspond to similar increases in totalproduction costs. In fact, a majority of respondentsindicated that their total operating costs had risenon the order of 20 per cent in 2007.Nearly half (46.9 per cent) of FHKI surveyrespondents indicated that expansion of the list ofindustries restricted for export processing wouldshrink their profit margins and another 36.4 percent indicated it would reduce their cash flow.Another 14.8 per cent indicated that they wouldavoid manufacturing or exporting affected products.Only 17.9 per cent of respondents believed thiswould have little impact on their firm.Despite concerns for their future registered byrespondents, 48.8 per cent would not considerrelocation to China’s western provinces, while43.8 per cent might do it in the long-run. As seenin Exhibit 16, more than half of the respondentsexpected to adopt automation to reduce labourcosts. More than half also expect to upgrade thevalue and value-added in their products. Over onefifth(20.4 per cent) expected to close down theirbusinesses in the PRD. Most of the companies thatexpected to close their businesses had no specifictimetable for doing so.Respondents were also asked to estimate thepercentage of firms in their industries that shutdown in the previous year and how many mightshut down in the next one to two years. Roughly athird of the respondents believed that less than 10per cent of companies in their industry had closed;roughly one-third believed that 10 per cent to 20per cent had shut down, and approximately 24 percent believed the percentage was higher than 20per cent. Roughly a third of respondents indicatedthat they believed 10 per cent to 20 per cent ofcompanies in their industry would close in the nextone to two years, while roughly a third believedthe percentage would be 20 per cent to 30 percent and approximately 17 per cent thought thepercentage would exceed 30 per cent closures (seeExhibit 17).Exhibit 16. Reactions to Cost Increases inSouth ChinaReactions (Multiple responses allowed)% of TotalRespondentsRelocate factories to other parts of Guangdong 17.9Relocate factories to mid and western regionsof China11.1Move factories to Southeast Asian countriessuch as Vietnam14.2Adopt automation to reduce labour cost 59.3Outsource the labour intensive processes 30.9Upgrade the production and develop valueaddedproducts58.0Close down business 20.4Source: Federation of Hong Kong Industries.Exhibit 17. Estimates of Firm Shutdowns inthe PRD by Hong Kong ManagersEstimated Percentageof ClosuresPast Year% of RespondentsNext One toTwo Years% of RespondentsLess than 10% 32.7 14.410% to 20% 36.5 33.820% to 30% 15.7 30.6Above 30% 8.2 16.9No comment 6.9 4.3Source: Federation of Hong Kong Industries.

38In terms of future outlook, 0.6 per cent ofrespondents said they were optimistic and wouldincrease investment, 64.8 per cent indicatedthat they would be cautious and adjust to thepolicy environment, 32.1 per cent said they werepessimistic and would gradually reduce investment,and 2.5 per cent had no comment.87 Hong Kong Trade Development Council, “Beyond CheapLabor: Building a Competitive Edge through AddingValue,” 5 September 2008.Hong Kong Trade DevelopmentCouncil (September 2008) 87In March and April of 2008, Hong Kong TradeDevelopment Council conducted a survey on theimpacts of the changing PRD business environmenton Hong Kong manufacturers and traders.According to the survey report issued in September2008, RMB appreciation had the greatest impacton Hong Kong companies in the PRD, followed bywage rises and the implementation of the LabourContract Law (see Exhibit 18). Survey findingsalso showed that SMEs had been impacted by theLabour Contract Law even more than larger firmsthat can more easily absorb the impact of labourcost increases (see Exhibit 19).Exhibit 18. Challenges Faced by Hong Kong Companies in PRDChallenges (1 = the largest impact and 5 the smallest)Severity of Impact% of EnterprisesAffectedAppreciation of RMB 1.66 97.4Rise in wages 1.76 97.4Implementation of the Labour Contract Law 1.86 96.5Inadequate labour supply 2.08 95.9Power / water shortage 2.35 94.4Implementation of the new Enterprise Income Tax Law 2.40 95.1Tightening of processing trade policies (e.g. Increases in restricted and prohibited categories) 2.40 92.6More stringent environmental requirements 2.46 94.9Rising land cost / more land use restrictions 2.72 88.8Source: Hong Kong Trade Development Council.Exhibit 19. Impacts of the Labour Contract Law on Enterprises of Different Sizes2007 TurnoverOverallAverage Equal or Less ThanHK$10 millionHK$10 million toHK$50 millionMore ThanHK$50 millionEstimated % increase in direct labour cost 23.5 24.8 23.4 21.5Estimated % increase in HR admin cost 21.3 24.1 20.3 17.6Source: Hong Kong Trade Development Council.

39In spite of these challenges, the majority of HongKong companies still gave positive responses toquestions of investment with a total of 53.3 percent of them planning to upgrade their technologyor raise their product value-added, while 29.9 percent planned to increase the mechanisation levelof their production. However, 3.1 per cent of thecompanies surveyed were planning to shut downtheir PRD operations. Most enterprises that claimedthey would shut down were smaller in size, with72.5 per cent having a turnover of HK$10 millionor less in 2007, 15.7 per cent having a turnover ofbetween HK$10 million and HK$15 million, andnone having a turnover exceeding HK$100 million.Exhibit 20. Hong Kong Companies’ Choice ofResponse to ChallengesResponse% of RespondentsRaise mechanisation level 29.9Upgrade technology and raise productvalue added53.3Suspend PRD expansion 14.0Scale down existing PRD operations 22.5Shut down existing PRD operations 3.1No plan yet 19.3Note: *Multiple answers allowed.Source: Hong Kong Trade Development Council.Federation of Hong Kong Industries(May 2009) 88In a March 2009 survey, the Federation of HongKong Industries found that the major difficultiesfor Hong Kong manufacturers since the globalfinancial crisis began was shrinking orders, followedby dwindling profit margins, rising operationcosts, high payment default rates, and sharplyrising financing costs. Manufacturers reported thatthey had experienced on average a 30 per centreduction in profit compared with the previous year.Operating costs were estimated to have increased17 per cent on average, with labour costs, rawmaterials costs, and appreciation of the RMB theprimary contributors to the rise in costs.Half of the manufacturers surveyed said they hadencountered payment defaults or delays from theircustomers equal to approximately 20 per centof their business turnover. Respondents also hadsuffered cuts to their bank credit lines on the orderof 30 per cent, and 25 per cent of manufacturerssaid that their interest expenses had increased by 30per cent. About 20 per cent of the manufacturerssurveyed indicated they had experienced problemsin obtaining bank loans.The survey found that, in light of the pooreconomic climate, manufacturers in general havetaken measures to mitigate the financial distressincluding postponing all new investment projects(41 per cent), outsourcing production (19 percent), investing in new products or equipment orto upgrade (17 per cent), relocating productionfacilities to Mainland cities other than the PRD (10per cent), relocating production facilities back toHong Kong or overseas (four per cent), and throughmerger or acquisition (one per cent) (see Exhibit 21).Exhibit 21. Measures Taken to Mitigate theEffects of the Economic DownturnMeasures% of RespondentsPostpone all new investment projects 41Outsource production 19Invest in new products or equipment toupgrade17Relocate production facilities to Mainlandcities outside the PRD10Relocate production facilities back to HongKong or overseas4Merger and Acquisition 1Source: Federation of Hong Kong Industries.88 Federation of Hong Kong Industries, “Survey on HongKong Enterprises in the PRD,” May 2009.

40In terms of Government actions taken to supportSMEs during the global economic crisis, the threemost popular actions taken by the Hong KongGovernment were the market promotion fundscheme for SMEs which 62 per cent of respondentsfound useful, the coverage expansion of ECIC (HongKong Export Credit Insurance Corporation) schemeswhich 56 per cent of respondents found useful, andthe HK$100 billion guarantee scheme which 51 percent of respondents found useful.Most of the measures released by the MainlandGovernment were well received by manufacturers.The suspension of the minimum wage increase wasrated as useful by 83 per cent of respondents, andthe reduction of administrative levies was ratedas useful by 82 per cent of respondents. Othermeasures considered useful by manufacturerswere the deferral of payment for social insurancecontributions (76 per cent), suspension of therequirement for cash payment of customs guarantee(69 per cent), an increase of export tax rebate rates(66 per cent), the expansion of SME loan guaranteeschemes (52 per cent), and financial support givento enterprises to upgrade and transform (52 percent).89 Federation of Hong Kong Industries, extract documentsfor “Survey on Hong Kong Manufacturers’ PRD Operationsin the Post-financial Crisis Environment,” November 2009.Federation of Hong Kong Industries(November 2009) 89With some signs of economic recovery visible inthe latter half of 2009, the Federation of HongKong Industries conducted another survey betweenOctober and November 2009 to get an update ofthe situation of Hong Kong’s PRD-based enterprises.Manufacturers reported that business had improvedduring the period July to September 2009. Comparedto the worst period of the financial crisis, most of therespondents reported that there was a 20 per centincrease in export value but a 10 per cent decrease inorder value. Although they saw a 20 per cent increasein credit availability, payment default rose 20 percent. Operating costs also increased 10 per cent. Thesummary of these changes is shown in Exhibit 22.Exhibit 22. Change in Firm PerformanceComparing to Earlier Periods, July-September2009Performance FactorsComparing tothe Worst Timeof Financial Crisis% of ChangesComparing toNormal TimesPreceding theFinancial CrisisExport value 20 -10Order value -10 -10Credit availability 20 -10Payment default 20 30Operating costs 10 10Source: Federation of Hong Kong Industries.The survey respondents identified their majordifficulties as labour shortages, an increase inlabour cost, a heavy tax burden, and weak overseasmarkets. Other difficulties they identified includeda fluctuation in export tax rebate rates, a lack ofmanagerial and technical talents, an inability tosecure credit lines, a lack of supporting industries,and the appreciation in the RMB. Firms reportedseveral means for coping with these difficulties,including restructuring and streamlining productionlines, developing new products or upgradingproduction technology, and reducing the number ofworkers, among others (see Exhibit 23).

41Exhibit 23. Measures Taken to Cope with thepost-Financial Crisis SituationMeasures% ofResponding FirmsRestructure company organisation andstreamline production lines76Develop new products or upgradeproduction technology59Reduce the number of workers 51Develop domestic sales 27Outsource production 27Engage in brand development and productupgrade22Transform from being in the processingtrade to being a foreign-invested company13Source: Federation of Hong Kong Industries.About 60 per cent of respondents indicated thatthe worst economic period was not over with only16 per cent holding the view that the worst ofthe economic crisis was behind them. However,respondents were quite optimistic regardingthe short-to-medium-term prospects for thePRD manufacturing industry with 57 per cent ofenterprises predicting that the operational situationat large would stabilise before the end of 2009 and22 per cent holding the view that it would graduallyimprove before the end of 2009. Less than 10per cent thought that the situation would worsenduring the next 12 months (see Exhibit 24).Exhibit 24. Expectations of the Situation forManufacturing in the PRDExpections% of Responding FirmsBy the End of 2009January toSeptember of 2010Stabilised 57 21Gradually improved 22 59Worsened 10 9No comments 11 14Source: Federation of Hong Kong Industries.Hong Kong Shippers’ Council(November 2009) 90Through the SME Development Fund, Hong Kong’sTrade and Industry Department funded a study onlogistics demand and on the cost of relocating HongKong manufacturing SMEs from Guangdong toother provinces. The project was organised by theHong Kong Shippers’ Council and the China BusinessCentre of Hong Kong Polytechnic University, andresults were published in December 2009.The report found that prior to the financial crisisHong Kong manufacturing SMEs were not activelyrelocating and that most of them had adopteda “wait and see” approach. The study groupinterviewed SMEs and found various obstacles torelocation. Interviewees expressed concerns that ifthey moved their operations they would not be ableto find a sufficient number of workers; that the coststhey might incur for land, water, electricity supply,and logistics were not clear; that the supply chainon which they depended could not be relocatedalong with their own operations; that they lacked theinternal capabilities to establish new branch factorieselsewhere; and that external factors did not supportrelocation because the SMEs could not get extraorders for the expanded production capabilities in thenew branch factories outside of Guangdong. In anyevent, the financial crisis of late 2008 largely put astop to industry relocation because now there was noneed for enterprises to expand their manufacturingcapability. For Hong Kong manufacturing SMEs theimmediate challenge to survive meant that they hadlittle time to think about relocating.The study found that the most likely trend is for HongKong manufacturing SMEs to remain in the PRD andin Guangdong Province, with a view to later followingand assisting MNCs and large Hong Kong enterprisesas they move to new locations and transform andupgrade those places in ways that make the locationspotentially more desirable to SMEs.90 Hong Kong Shipper’s Council, “A Study on Logistics Demandand the Cost of Hong Kong Manufacturing SMEs Relocationfrom Guangdong to other Provinces,” November 2009.

42Hong Kong Trade DevelopmentCouncil (January 2010) 91In January 2010, the Hong Kong Trade DevelopmentCouncil conducted a survey to gather the latestopinions of Hong Kong companies regarding theirviews on business prospects, the current ordersituation, as well as likely changes in the tradingpractices of overseas buyers. The results of the surveyrevealed that Hong Kong exporters were cautiouslyoptimistic as to the business outlook for 2010. A totalof 35 per cent of the surveyed companies believedthat their export performance would be better in2010 than in 2009, while 52 per cent thought thattheir businesses would perform at about the samelevel. 50 per cent of the surveyed companies thoughtthat their sales to Mainland China would fare betterin 2010, with 37 per cent thinking that sales to LatinAmerica would improve, and 32 per cent believingthat sales to Central and Eastern Europe would getbetter in 2010 (see Exhibit 25).Exhibit 25. Business Outlook for 2010 byExport Market (January 2010)NeutralOptimisticOverall 52 35Chinese Mainland 42 50Latin America 52 37Central and Eastern Europe 56 32Western Europe 55 31Japan 52 32United States 48 35Source: Hong Kong Trade Development Council.By industry sector, 51 per cent of respondentsthought that the market for consumer electronicswould improve in major markets in 2010, with 42per cent holding that view for watches and clocks,35 per cent for footwear, 35 per cent for preciousjewellery, 34 per cent for toys and games, and 32per cent for clothing (see Exhibit 26).Exhibit 26. Business Outlook for 2010 byProductProduct Neutral OptimisticFootwear 58 35Consumer electronics 40 51Watches and clocks 47 42Clothing 54 32Household products 57 29Imitation jewellery 57 28Toys and games 48 34Precious jewellery 47 35Source: Hong Kong Trade Development Council.The respondents were asked to indicate the likelychanges in trading practices of their clients in 2010as compared to 2009. Most respondents agreed thatthere would be an increase in the number of ordersplaced, that buyers would increase their inventorylevels, and that the average quantity of orders wouldincrease. However, most respondents disagreedthat buyers would place orders earlier, shortencredit periods, or allow for longer delivery leadtimes. Thus the trading environment facing HongKong manufacturers seemed to remain challengingthroughout 2010 (see Exhibit 27).Exhibit 27. Trading Practices of OverseasBuyers in 2010 vs. 2009PracticeMeanResponseBuyers will order a wider variety of products 3.23Export products will fetch higher prices 3.16Buyers will place more orders 3.14Buyers’ inventory levels will be higher 3.11Average quantity per order will be higher 3.01Buyers will place orders earlier 2.81Buyers will agree to shorter credit period 2.65Buyers will allow longer delivery lead time 2.58Note: On a scale of one to five, with one suggesting “stronglydisagree” and five suggesting “strongly agree.”Source: Hong Kong Trade Development Council.91 Hong Kong Trade Development Council, “On the RoadRecovery: Assessment of 2009 Christmas Sales in MajorMarkets,” 29 January 2010.

43The Chinese Manufacturers’Association of Hong Kong (April2010) 92In March and April of 2010, The ChineseManufacturers’ Association of Hong Kong (CMA)conducted a survey to understand the businessenvironment in the PRD, members’ perspective onthe business outlook, and strategies to cope withchallenges and to grasp opportunities. The 2010survey indicated that prospects were improving sincesimilar surveys carried out in 2008 93 and 2009. 94 Themost important factors affecting business reportedin the 2010 survey were labour costs, raw materialprices, additional costs and risk arising from labourlaw and regulations, and risk of appreciationof the RMB (see Exhibit 28). With the economyrecovering, increasing operating costs once againhave become the prime concern of the Hong Kongfirms. The CMA found that the strategies that firmsadopted are similar across the three years, but the2010 results showed a strengthening in efforts inindustrial upgrading, transformation, and relocation(see Exhibit 29). A further breakdown of some ofthe strategies may be found in Exhibit 30.92 The Chinese Manufacturers’ Association of Hong Kong, “Surveyon Members’ Views on the Business Environment in the PearlRiver Delta,” April 2010.93 The Chinese Manufacturers’ Association of Hong Kong, “Surveyon Members’ Views on the Business Environment in the PearlRiver Delta,” April 2008.94 The Chinese Manufacturers’ Association of Hong Kong, “Surveyon Members’ Views on the Business Environment in the PearlRiver Delta,” April 2009.Exhibit 28. Factors Affecting the Operation of Hong Kong Manufacturers in the PRDMain Factors Affecting Business Operation 2008 2009 2010Raising / expensive labour costs 3.52 3.04 3.61Raising / high raw material prices 3.52 2.73 3.45Additional costs and risk arising from labour laws and regulations 3.46 3.22 3.44Risk arises from change of RMB exchange rate 3.49 2.89 3.20Customers pressing prices na 2.98 3.13Labour shortage 3.05 na 3.09Insufficient orders na 3.08 2.39Short supply of water and electricity 3.27 na naNote: 4= “very severe impact,” 3= “severe impact,” 2= “some impact,” 1= “no impact,” na = not available.Source: The Chinese Manufacturers’ Association of Hong Kong.Exhibit 29. Strategies Adopted by Hong Kong Manufacturers, April 2010Rank Strategies Proportion of Companies Adopting the Strategy (%)1 Expand markets 73.82 Improve the quality level / value-added of products 66.33 Develop more new products 59.44 Upgrade technology 56.35 Improve technical or operating process 53.86 Adopt advanced machines / equipment 46.97 Outsource certain production procedures 41.38 Relocate the factories 33.18 Merger or reorganisation 33.110 Branding 26.911 Give up manufacturing and switch to trading business 14.412 Close down the business 5.6Note: Each responding company can choose more than one strategy.Source: The Chinese Manufacturers’ Association of Hong Kong.

44While an increasing number of Hong Kongmanufacturers planned to sell into the Chinamarket, the survey noted several difficulties in doingso. Over 70 per cent of respondents indicatedthat taxes and fees for domestic sales, approvaland regulatory procedures, and restrictions on thedomestic sales of processing trade goods have “verysevere” or “severe” impact on their sales in China.Nearly 60 per cent of the responding companiesindicated that piracy, lack of information oncustomers’ credit status, price disadvantages, lackof human resources familiar with sales in China,and lack of suitable distributing channels pose greatdifficulties for their domestic sales business.The responses indicated that despite muchdiscussion of operating modes over the last severalyears, Hong Kong companies had evolved theirbusiness models very little since a similar surveywas carried out in 2001, with OEM operations stilldominating over ODM or OBM (see Exhibit 31).Exhibit 30. Detailed Tactics Adopted by Hong Kong Manufacturers, April 2010Strategies% of Companies Adopting the StrategyExpand markets•• Strengthen relations with existing customers54.4•• Speed up expansion into the Mainland domestic market39.4•• Attend more exhibitions/trade fairs34.4•• Increase advertisement in the press or increase promotion activities19.4•• Expand into e-marketing or e-trading15.6•• Expand into other emerging markets11.3Upgrade technology•• Strengthen own-R&D43.8•• Cooperate with universities, research institutions in the Chinese Mainland16.3•• Purchase new scientific technologies from the markets15.6•• Cooperate with universities and research centres in Hong Kong11.9Relocate the manufacturing business to other areas•• To more backward areas in Guangdong province15.0•• To mid and western areas of the Chinese Mainland10.6•• To other countries5.6•• To other areas of the Chinese Mainland5.0•• To the environment-protection industrial parks in the PRD3.8•• Back to Hong Kong3.8Source: The Chinese Manufacturers’ Association of Hong Kong.Exhibit 31. Changes in the Operation Modes of Hong Kong Firms in the PRDOperation ModeProportion in Responding Companies (%) Proportion in Total Sales (%, weighted average)2001 2010 2001 2010OEM 73.2 83 50.9 56.0ODM 53.0 49.7 24.1 20.1OBM 35.0 37.7 21.6 22.6Others 4.8 1.3 3.4 1.3Total 100 100 100 100Source: The Chinese Manufacturers’ Association of Hong Kong.

45Industry Situation ReportsWhile it is useful to get the aggregate picture of thechallenges facing Hong Kong’s manufacturing SMEsand some of the strategies employed to meet thesechallenges, it is also useful to identify the particularcompetitive challenges at the industry level andthe strategies that some individual firms have usedto survive and succeed in the marketplace. Herewe will focus on the watch and clock, consumerelectronics, garments, mould and die, and toyindustries. These were selected due to theirimportance, but also because they highlight issuesthat arise in different competitive environments.The Watch and Clock IndustryWatches can be categorised as mechanical,radio controlled, or digital. Markets exist forcommercial watches, leisure and fashion watches,and sports watches. The watch and clock industrymanufacturing chain comprises mould making,injection moulding, electroplating, movementmanufacturing, case making, strap making, productassembly, and quality testing.Most of the important players in the global watchindustry are in Switzerland, Japan, Hong Kong, andMainland China. Presently, Swiss manufacturers areviewed as being unbeatable in terms of producinghigh-end branded watches. Most of the famousbrands and high value brands are Swiss. It is almostuniversally accepted that Swiss made watches are ofbetter quality than watches made elsewhere. Manyretail customers will pay a premium for a Swissmade watch, even if it is otherwise branded thesame and looks the same.Chinese firms tend to occupy the low-end ofthe OEM market, but an increasing number ofChinese firms have or are trying to develop theirown brands. In 2007, China exported 1.38 billionwatches and clock products. 95 Electronic productswith mechanical indicators account for over 70 percent of China’s export volume. 96 OEM customerstend to use Chinese companies if they are focusedon getting the lowest possible price.Hong Kong firms operate mostly in the mid to lowendrange of the sector. They have a dominantposition in the mid-range watch segment. MostHong Kong firms focus on OEM production, buta few have branched out into ODM and OBM.Most Hong Kong firms are experienced marketerswith established distribution channels. This makesit difficult for firms from the Chinese Mainland tocompete with them. Lower costs in Mainland China,and pressure from customers to compete withChinese manufacturers, have led nearly all HongKong watch companies to relocate most of theirproduction to the Chinese Mainland. In addition, itis increasingly hard to get workers in Hong Kong towork in the manufacturing sector. OEM customerstend to buy from Hong Kong manufacturers if theyare after watches that are of reasonable quality andprice, and if they value some of the value-addedservices such as design and after-sales service thatHong Kong firms can offer.Industry participants do not expect new locationsto emerge to rival Switzerland, Hong Kong, andMainland China in watch production for at leastthe next decade. Watch manufacturers need to beclose to factories producing cases, bracelets, hands,straps, and other components. If a watch companytried to move to a location without an establishedsupply chain, the likely outcome would beproduction delays that OEM customers would findintolerable. This makes it difficult for other low-costlocations to become established and contributed tothe decline of the Japanese industry, which now isdominated by Seiko, Citizen, and Casio, the OEMbusiness having been lost due to high costs and theloss of the supply chain.95 www.ceu.com.cn96 Watch Industry, Alibaba.com Industry Report.

46Basic Facts about the IndustryGross Industrial Output (GIO) for Hong Kong wasHK$1.7 billion in 2008 for the watch and clocksector. Employment for the sector in Hong Kong isrelatively low with 871 persons employed with anestimated average annual wage of HK$297,359.Wages were approximately 17 per cent of totalcosts. 97Average wages for the sector in HongKong are 10 times those for the sector in Chinaas a whole. This is likely explained by generalwage disparities between Hong Kong and China,the employment of more senior staff in HongKong, and the fact that higher value end productsare produced in the sector in Hong Kong withcorrespondingly more costly labour inputs.Exhibit 32. Average Monthly Wages for theSector in RMBRegionAverage Monthly WagesHong Kong 21,806YRD 2,140PRD 2,163China 2,265Sources: Foshan, Dongguan, Shenzhen, Huizhou, Taizhou (JS), Nantong,Shaoxing, and Jiaxing City Statistical Yearbooks, 2009, China StatisticalYearbook, 2009.97 Hong Kong Census and Statistics Department data on“Professional & scientific, measuring & controlling equipment,n.e.c.,& photographic & optical goods,” 2009.98 www.86mdo.com99 Watch Industry, Alibaba.com Industry Report.100 Yearbook of Shenzhen, www.sz.gov.cn.The watch industry is one of Hong Kong’s fourmajor export industries. Hong Kong is the world’ssecond largest watch exporter by value afterSwitzerland, and Hong Kong is the world’s secondlargest exporter by quantity after China. In 2009,Hong Kong exported HK$43.7 billion watchesand clocks, a decrease of 20.8 per cent over theprevious year. The top three markets for the exportof Hong Kong watches and clocks are the UnitedStates, China, and Switzerland, accounting for 42per cent of the total value of watches and clocksexported (Exhibit 33). Total re-exports from HongKong of watches and clocks in 2009 were HK$43.4billion or 1.8 per cent of total re-exports. Mainlandbased processing trade companies re-exportingthrough Hong Kong accounted for HK$16.9 billionof this total (Exhibit 34), while Mainland based nonprocessingtrade companies accounted for a furtherHK$6.3 billion.In 2009, Hong Kong imported HK$39.2 billionwatches and clocks, 18.3 per cent lower than theprevious year. The top three suppliers of watchesto Hong Kong by value were Switzerland (41.6 percent), China (34.5 per cent), and Japan (11.9 percent) (See Exhibit 35).China accounts for 70 per cent of global productionof watches and clocks by volume but only 30per cent by Gross Industrial Output. 98 The watchindustry in China has formed a cluster developmentstructure with small and medium-sized enterprisesat its core. Private enterprises and foreign-fundedenterprises are expanding rapidly and they presentlyaccount for over 70 per cent of all the enterprises inthe sector in China. 99 In 2008, the gross output ofthe watch and clock industry in Shenzhen was RMB15 billion. Shenzhen accounted for more than 50per cent of China’s gross output and export volumefor watches and clocks. Branded watches made inShenzhen captured 63 per cent of the MainlandChina market for branded watches in 2008. 100At the end of 2008, there were about 1,000watch manufacturing enterprises in Shenzhen.Approximately 200 of these enterprises were eitherlarge or medium-sized. These firms employed

47Exhibit 33. Exports of Watches & Clocks from Hong Kong, HK$ millionsDestination2007 2008 2009Value Y-on-Y Change Value Y-on-Y Change Value Y-on-Y ChangeWorld 49,958 6.3% 55,204 10.5% 43,730 -20.8%United States 9,059 -3.9% 9,490 4.8% 7,096 -25.2%Mainland China 7,033 11.5% 7,937 12.9% 6,088 -23.3%Switzerland 5,374 23.9% 6,233 16% 5,228 -16.1%Source: Hong Kong Trade Statistics, Census and Statistics Department.Exhibit 34. Chinese Mainland Process Industry Watches and Clocks Re-exported from Hong Kong,HK$ millionsWatches and Clocks Re-export of Processing Products Manufactured in theChinese Mainland2006 2007 2008 2009Value 21,240 21,693 21,765 16,940Source: Hong Kong Census and Statistics Department.Exhibit 35. Imports of Watches and Clocks to Hong Kong, HK$ millionsSource2007 2008 2009Value Y-on-Y Change Value Y-on-Y Change Value Y-on-Y ChangeWorld 41,204 21.4% 47,994 16.5% 39,220 -18.3%Switzerland 15,904 45.7% 20,126 26.5% 16,321 -18.9%Mainland China 14,909 6.8% 17,382 16.6% 13,528 -22.2%Japan 5,431 4.8% 5,671 4.4% 4,670 -17.7%Source: Hong Kong Trade Statistics, Census and Statistics Department.200,000 people and produced 800 million watchesand clocks.By the end of 2008, there were 2,000 Hong Kongfundedwatch and clock and related accessoriesenterprises in the PRD.Issues for Hong Kong Watch ManufacturersHong Kong’s watch and clock sector is facing severalissues. These include the global economic downturn,powerful buyers, tough competition, RMBappreciation, labour availability, wage increases, andincreases in utility and material costs. Additionally,legal and regulatory changes regarding processingtrade, labour law, the environment, and safety havealso been implemented and must be managed.The downturn in the global economy that beganin force in September 2008 led to banks tighteningtheir credit terms for manufacturers, decreasedorders for watches, and increased business carryingcosts for the watch and clock sector as a whole. 101Trade credit and other lending for the industrylargely dried up for a period of time, making it verydifficult to operate, particularly for firms that hadnot set aside sufficient cash reserves.101 Hong Kong Watch Manufacturers Association.

48An early sign of the slump was that there were20 per cent fewer exhibitors from Asia at theApril 2009 BASELWORLD Watch and JewelleryShow than in 2008. Exhibitors stayed away in thebelief that order numbers and volumes would fall.Indeed, exports from Hong Kong and China fellby around 20 per cent from 2008 and some firmsexperienced even steeper declines in orders. By thefourth quarter of 2009, the situation had improvedsomewhat. Sales of the Hong Kong manufacturersduring the Christmas period in 2009 were 15 percent lower than in 2008, a better situation thanhad been envisioned just a few months earlier. 102 Asurvey released by HKTDC in January 2010 103 showsthat 47 per cent of exporters held a neutral viewand 42 per cent of exporters were positive on theglobal watch and clock sales for the 2010 Christmasperiod.The industry has estimated that demand is unlikely toreturn to pre-crisis levels and that the sector wouldnot recover in a sustained manner until mid 2010.The domestic market in Mainland China seems tohave been the market that was least affected by thecrisis, and it is likely to recover first. 104 It is thoughtthat the European and American markets willbounce back before markets in South-East Asia. TheEastern European markets are expected to take thelongest time to recover. 105The global downturn also affected the customers ofHong Kong manufacturing SMEs, particularly thosein the OEM segment. These customers put evenmore pressure on watch and clock manufacturersto reduce prices while at the same time improvingthe quality and design of their products. OEMcustomers know the costs of all the producers anduse this knowledge to effectively push for lower andlower prices.102 news.cetra.org.tw.103 See Hong Kong Trade Development Council, “On the Roadto Recovery: Assessment of 2009 Christmas Sales in MajorMarkets,” 29 January 2010.104 news.cetra.org.tw.105 news.cetra.org.tw.The OEM customers are able to bargain aggressivelyd u e t o t o u g h c o m p e t i t i o n a m o n g w a t c hmanufacturers. Industry participants indicate thatcompetition has grown more intense in the industryin recent years, particularly in the OEM segment.With relatively low entry costs, particularly in China,more and more players are entering the industry.New entrants mainly enter the OEM segmentbecause it is much more costly to set up a brandedwatch company than it is to do high volumecontract manufacturing. Some companies enter theindustry by subcontracting space in a factory ownedby other parties and don’t incur any capital costspreferring instead to focus their efforts and theircapital on establishing customer relationships. HongKong SMEs operating in the Chinese Mainlandgenerally face cost disadvantages versus Chinesecompetitors due to higher salaries for managers,higher compliance costs, and higher design costs(many Chinese firms do no design themselves).Hong Kong watch and clock manufacturers withfactories in the Chinese Mainland have also beenaffected by policies in Guangdong and China ingeneral. Current export processing policies in theChinese Mainland do not affect watch assemblyor the sourcing of component inputs such asmovements (electronic and mechanical), watchand clock cases (metal, plastic and wood), finishedwatch glasses, and straps. However, the importof raw materials that would go into the domesticmanufacture of these inputs may come under thepolicies. While watch assembly is not consideredpolluting, the electroplating process necessary formost watch components is. Thus the watch supplychain is coming under pressure from environmentalregulations.The Labour Contract Law applies across allindustries and firms. Watch companies operating inChina report that the Law has raised administrativeand worker benefit costs significantly and has madeit more difficult to deal with seasonal fluctuationsin demand through overtime and seasonal work.While in theory the Law should affect all firmsequally, and since industry participants believe

49that it is unlikely production would leave China,eventually such costs should result in higher prices.However, individual firms (particularly SMEs) findit difficult to pass on cost increases in the face ofpowerful buyers, as SMEs find it more difficultto take on the added administrative burden thanlarger firms, and some Hong Kong companiesbelieve that Mainland Chinese firms are able (orwilling) to skirt the Law. As a result, the HongKong SMEs are disproportionately disadvantagedby its implementation. Since the impact should begreatest for the most labour intensive industries,the impact of the Law on Hong Kong’s watch andclock companies is likely to be middling comparedto other industries, with more labour-intensiveindustries like garment and toy more affected, andless labour-intensive industries like mould and dieless affected.The watch and clock industry has been subject topressure to move out of the Pearl River Delta or outof Guangdong completely under the Ministry ofCommerce’s “Opinion on Supporting the Middleand Western Regions’ Reception of Processing TradeRelocation” (November 2007) 106 and Guangdong’s“Decision on Promoting the Relocations ofIndustries and Labour Force.” 107 Such relocation isproblematic because watch production dependson a dense supply network. Hong Kong watchfirms are attracted to the PRD due to the presenceof a complete network of suppliers of parts,components, and services such as electroplating.In an effort to encourage relocation, HepingCounty (Heyuan, Guangdong) and Shenzhenjointly established a watch industry relocation parkin 2006 with an investment of RMB 8 billion. Thepark, which aims to attract 200 firms and to provide100,000 jobs, has planned a centralised testingcentre and a centralised electroplating facility (mostwatch components need to be electroplated) tominimise pollution. As of mid-2009, 41 watchfirms were located in the Park, but relocations hadslowed due to the financial crisis. It is yet to be seenwhether the park will result in large scale movementof the industry from Shenzhen, or whether it willresult in consolidation of the industry, but it is clearthat the overall policy direction is to move watchproduction out of the core areas of the PRD.Response Strategies of Hong Kong SMEsHong Kong watch and clock manufacturers haveundertaken a variety of strategies to deal withrecent pressures. In general, Hong Kong watch andclock manufacturers are attempting to maintaintheir presence in traditional OEM manufacturingwhile at the same time trying to add value toexisting products, develop new high value addingproducts, develop their own brands, find newmarkets for their products, and work out their salesplans so as to achieve sustainable development. Wenote the following:• The downturn in traditional markets has led manyHong Kong firms to seek markets elsewhere,including Mainland China and the Middle East.For example, a 2008 survey by the HKTDC 108showed that 89 per cent of respondents wereoptimistic about the sales of watches to MainlandChina. Developing new markets takes time,however, and the scale of potential new marketseven if deeply penetrated does not currentlycompare to that of the existing European andAmerican markets.• Penetrating the China market will be difficultfor many Hong Kong SMEs, because exportprocessing and OEM business is very differentfrom distributing and selling within China. HongKong SMEs tend to be good at controlling costs,but are less knowledgeable about consumers,marketing, and distribution. Thus they mayencounter difficulties in building a businessaround domestic sales in China unless theyreconfigure their business model.106 www.gov.cn107 www.gdsme.com.cn108 Hong Kong Trade Development Council, “Offshore Trade andProduction: Development and Implications” 5 February 2008.

50• Contract manufacturing is a commodity businessand companies that only do OEM are likely tohave a limited life or limited profits and limitedgrowth unless they can provide superior oradditional services to their customers. Companiesin the OEM segment must either face difficultprice competition or look to develop by addingvalue through other means as well.• One area in which Hong Kong firms havetraditionally distinguished themselves fromMainland Chinese firms is in design and ODMbusiness. Many Hong Kong SMEs are investing indesign capabilities in an effort to build sustainablerelations with key customers. This may be difficultand costly to do, but is one way to try to stayaway from competition based totally on cost.• Entering the branded watch business (OBM)is also viewed as a potential strategy, but thisinvolves a large investment and long lead times,with uncertain chance of success. Building abranded business is hard for export processingfirms, especially for SMEs that may lack thefinancial scale, managerial resources, andgeographic reach required to be a successfulbranded watch company.• Other options that have been explored includesubcontracting production to others, becominga subcontractor to larger companies, relocatingto the Heping County Park, moving into retailing,and -when all else fails- exiting the business.Case Study – Renley Watch ManufacturingCompany LimitedRenley Watch Manufacturing Company Limited(Renley) is a Hong Kong based watch companyengaged in OEM, ODM, and OBM watch productionas well as watch retailing. Renley produces 80,000to 100,000 watches per month in facilities inHong Kong and Switzerland for OEM customers(and an unspecified number for its own brandedproduction), has a watch components factory inDongguan, and has watch retail outlets in HongKong (4) and the Chinese Mainland (8).Renley was established by Mr Stanley Lau in 1983after he had spent 10 years working for otherfirms in the industry. Renley was started with aninvestment of HK$200,000, 1,800 square feetof space in Tsuen Wan, 10 employees, and twocustomers (one from the US and one from Japan).Renley got into watch design when a company thatheld the licence for Asian markets for a well-knownFrench watch brand asked Renley to create a watchcollection that was stylish yet reasonably priced.Renley manufactured the watches and the companyholding the licence handled the sales and marketingof the watches. When this business faced adownturn, Renley decided to reduce its dependenceon a single customer and participated in trade fairsand exhibitions in various countries to make newcontacts, find new customers, and develop thecompany’s reputation.In the early 1990s, when most Hong Kong watchmanufacturers shifted production to the ChineseMainland, Renley decided to retain production inHong Kong, acquired three Swiss watch brands,and opened a factory in Switzerland to manufacturepremium quality Swiss-made watches. In 1999,Renley established a retail business, GlobalTimepieces, to sell its own brands as well as otherbrands such as Tissot, Cartier and Omega directto end consumers. The retail outlets in China arenamed “IN-Style” and sell style watches such asGucci, Burberry, Armani, as well as Renley’s ownbrands, though the merchandise mix in the ChineseMainland shops is focused on brands lower-pricedthan the Hong Kong shops due to differences inlocal demand.Today, Renley’s activities include design, production,sales, and after-sales service of watches. Renleyproduces a range of watch styles including classic,sporty, dressy, jewellery, character, and fashion.Most of the watches that Renley manufactures arepriced in the range of HK$1,000 to HK$50,000with some watches priced much higher, particularlythe watches produced in the Swiss factory. Renleyhas 25,000 square feet of manufacturing spacein Hong Kong, including a 20,000 square foot

51factory in Cheung Sha Wan. The company openeda components factory in Dongguan in 2003, butdoes all of its watch assembly in Hong Kong andSwitzerland. The company has 150 employees inHong Kong, 400 employees in Mainalnd China, and25 employees in Switzerland. Roughly 40 per centof revenues come from the OEM business, 20 percent from the OBM business, and 40 per cent fromretailing. The OEM business is 30 per cent from theUS, 30 per cent from Europe, and 40 per cent fromthe rest of the world. In the period 1983 to 2010,Renley’s revenues increased more than twentyfold.Issues and ChallengesRenley has faced a number of significant challengesin the course of its history. One has been a seriesof economic downturns. The global economicdownturn associated with the dot com collapseand the 9/11 attacks affected markets worldwide.During the SARS period in 2003, suddenly therewere no customers and no business, but the costsfor rent and staff still needed to be covered. Similarissues arose during the global economic downturnof 2008-2009, with business down sharply anduncertain prospects. Fortunately business reboundedin 2010 to more normal levels.Another major issue has been competitive pressures.In the branded watch business, Swiss and Japanesecompanies are the main competitors, but in generalHong Kong companies can do reasonably well inmoderately-priced branded watches. In the OEMbusiness, however, strong competitive pressurecomes from companies that are manufacturing inthe Chinese Mainland. Customers use quotationsfor contract manufacturing in China to try to obtainlower prices. While producing in Hong Kong meansthat Renley has not had to face rapidly rising wagesin the Pearl River Delta to a great extent, its HongKong workforce receives wages on the order of threetimes that received in the PRD, which has heightenedthe competitive pressures in the OEM business.In addition to wages, even finding the right workersin Hong Kong has been a challenge at times inspite of the fact that Renley pays comparativelyhigh wages for the industry. This is due to a generalshortage of workers in the industry in Hong Kong.Not having sufficient workers has made it difficultto expand as quickly as Renley might like and mayeventually make it difficult to continue to producewatches in Hong Kong if a sufficient number ofworkers cannot be found.Managing cash flow was an early issue for thecompany. As a small factory, Renley struggled tocollect cash quickly from its customers in order to beable to pay suppliers and staff in a timely manner.In its first months of operation, Renley focusedon developing the documentation and bankingrelations in order to ensure that its trade finance,payments, and receipt system was in place so thatthe company could meet its cash commitments.Another challenge in Renley’s early history waswhen a customer that accounted for 60 per cent ofRenley’s business ran into difficulty. Renley suddenlyhad to fill the gap that was left as their largestsource of revenue retreated.Expanding into branded watches and retailingalso presented challenges. The branded watchbusiness was unfamiliar to Renley’s management.Renley’s team knew how to make watches, but nothow to manage a brand. Similar difficulties wereencountered when Renley moved into retailing.Some of the retail outlets that were set up in theearly days were in poor locations and the companyended up having to close them. The sharp increasein rent in some locations was also unexpected andcreated difficulties. Renley estimates it took threeto five years to work out issues associated with itsinitial forays into branded goods and retailing.

52Renley has faced no major regulatory issues andthe company’s experience in Hong Kong andSwitzerland has been similar with both locationsbeing transparent in terms of what is required ofcompanies. In China, the regulatory environmentis more challenging. Government officials take amore active interest in the business and it is likelythat companies will be visited by the Labour Bureau,the Tax office, and Customs officials, who are likelyto tour the company’s factories. Cooperating withthese officials takes time and costs money. In generalterms, doing business in Switzerland and Hong Kongis far simpler than doing business in China.Company StrategyWhile Mr Lau doesn’t view Renley as being all thatsuccessful and comments that the company is “stilllearning,” the reality is that Renley has survivedand grown through some difficult periods. MrLau attributes this record in part to foresight. Hebelieves that whatever the industry, a company’smanagement should forecast for the next 10 years.In the case of Renley he points out that “nowadayseverybody is talking about branding, but we weredoing research and development in Switzerland andstarted a branded watch business long before it wasa very popular strategy. Friends took the view thatour OEM business was good and that we shouldjust focus on that, but I could see that just doingOEM had limited potential. Some of the companiesthat we used to compete with in doing OEM arenow out of business.”As other Hong Kong watch manufacturers weremoving production to the Chinese Mainland in theearly 1990s, Renley decided to differentiate itselffrom the competition by staying in Hong Kong andobtaining facilities in Switzerland to make highervaluewatches. At around the same time, Renleyacquired three Swiss watch brands, including brands,technology, stores, and in one case a factory.Renley’s manufacturing and branded businessesin Switzerland keep it in close contact with theSwiss market, resulting in good contacts with otherindustry players, bankers and other professionalsthat work with watchmakers. In recent years, Renleyhas been more active in selling its branded productsinto the Chinese Mainland. Renley finds that someChinese customers prefer a Hong Kong madewatch because they are generally better quality thanwatches made in Mainland China.Although Renley produces some of its owncomponents, it is principally an assembler with keycomponents purchased from Switzerland, Japan,Taiwan, Thailand, Korea, and China. The companyhas decided not to relocate its main manufacturingto the Chinese Mainland. It sees merit in continuingto do most of its manufacturing in Switzerland andHong Kong. This is due in significant part to thefact that Swiss-made watches and to a less extentHong Kong-made watches can command a pricepremium versus other watches. An advantage ofmanufacturing in Hong Kong is the flexibility tosource components from different supply locationssuch as Japan and the PRD, which allows Renley tofocus more on design.Renley’s strategy is not to chase other companiesin trying to make cheaper and cheaper watches,it is to make better quality watches in Switzerlandand Hong Kong that will sell at a higher price.The strategy is to carve out a niche in makingwatches that are innovative and well designed,and to follow-up with good service. This approachis supported by a research and development staffof 10 and the ability to make watch samples in acontrolled environment that minimises the risk thatdesigns will be appropriated by others.Renley’s retailing activities began in 1999. Asubsidiary, “Global Timepieces,” was set up as aseparate company that would sell a range of watchbrands such as Cartier, Omega, Piaget, and others,not just Renley-owned brands. In Mr Lau’s view, thismade Global Timepieces more competitive as a watchretailer. The opening of the watch retailing businessresulted in Renley being diversified across the watchsector as an OEM, ODM, and OBM company, givingthe company greater depth and strength.

53Renley focuses a good deal of attention on stafftraining. Its Hong Kong production staff is trainedby its Swiss technicians in traditional Swiss assemblymethods for producing high quality watches. Thisgives the company a standard of quality assurancethat many other companies cannot emulate. In1994, Renley was the first watch manufacturer inHong Kong to obtain ISO9001 certification and allits operating procedures are based on the ISO9001standard for quality assurance. Renley has receivedquality awards from the Hong Kong ProductivityCouncil, the Hong Kong Industry Department, andfrom others.On other operational issues, in terms of cashmanagement Renley has established a goodrelationship with its bank and has set aside a cashreserve to act as a buffer against short-to-mediumtermissues such as SARS and economic downturns.To overcome overdependence on one customer,Renley decided to expand its marketing activitiesand participate in more trade fairs and exhibitions.The company also focused on diversifying to includeODM and OBM to move beyond price-competitiveOEM operations.In terms of management, Mr Lau manages thecompany very closely. He thinks that the way todeal with challenges and issues that often areunforeseen is to be informed and “hands on.” Tothis end, Mr Lau gets daily reports from his toplinemanagers, and speaks to them either in personor via telephone during most working days. Duringdiscussions with his management team, Mr Lauremains open-minded and receptive to their ideas.Once Mr Lau has considered the thoughts of hismanagers, conclusions are drawn and decisionsare made and implemented together as a team.Mr Lau has found that this approach motivatesstaff and results in a happier and more productiveworkplace.Renley has overcome most of its challenges byfocusing on niche market opportunities, by doingthings differently, and not blindly following the packof other companies in the watch industry, and byfocusing on value adding activities such as researchand development, innovation, design, and branding.Future PlansRenley’s goal over the next decade is to become aleader in watch manufacturing and in operating abranded watch business in Hong Kong. In addition,Renley plans to grow its retail network, mainly inChina but also in Hong Kong, as well as focusingon the development of its watch brands. Expandingthe OEM business will be a lower priority given thecommodity nature of that business.Renley will keep manufacturing in Switzerlandbecause the company still has a lot of customerswho want Swiss-made watches. Renley will alsocontinue manufacturing in Hong Kong because itis easy for Mr Lau to manage and because manymembers of Renley’s Hong Kong staff have beenwith the company for up to 25 years and are veryexperienced in making watches. However, Mr Laufeels that the Hong Kong factory may get smalleras some of his Hong Kong based staff retire, notingthat it is quite difficult to find new staff in HongKong who have the skills that Renley needs. For thetime being, Renley is still reluctant to do large scalemanufacturing in China because of uncertainty inlabour markets and regulation.

54Lessons from the Renley CaseThere are a number of lessons that can be learnedfrom the Renley case.• While the challenges facing entrepreneurs inHong Kong’s manufacturing SMEs are greaterthan before, in some ways the opportunitiesare also greater as new markets and sources ofsupply become available.• Risks are always present in business. The key isto identify and manage these risks to the extentpossible.• To be successful, SME managers must bemotivated and focused on the needs of thebusiness.• Even SMEs need to forecast what their industrywill look like in five to 10 years and to identifypotential market opportunities that will develop.• SMEs should focus on businesses the ownermanagerknows. Renley was founded after MrLau had worked in the watch industry for tenyears.• Aggressive cash management and developinggood relations with banks can be critical,particularly in the early years for SMEs.• Thinking ahead to where the business should bein five to 10 years is important if a firm is goingto stay ahead of the curve.• While the vast majority of Hong Kong watchmanufacturers have moved watch productioninto the Chinese Mainland, it is possible tosucceed while retaining production in HongKong, and even in producing in a more expensivelocation (Switzerland).• It is important to match production location withdifferent segments of the market and customers’willingness to pay for production in differentlocations.• It is possible for Hong Kong manufacturers tomove beyond OEM production to ODM and OBMproduction, and even into retailing. In order tomove beyond OEM production, firms must investin design capabilities, must take the time tolearn to manage brands, and / or learn to servecustomers directly. While these things may bedifficult to do, it is certainly possible.• It is also possible for Hong Kong manufacturersto simultaneously engage in OEM, ODM, OBM,and retail activities.• Providing high-quality service can lead to positivelong-term relationships with key customers.• Acquisition of foreign brands can be an effectivemeans of entering OBM businesses. Even so,it can take five years to learn how to managebrands effectively.• The Chinese Mainland offers an unprecedentedopportunity for Hong Kong SMEs to develop andsell their own brands and to get into retailing.• Worker training is key to producing high qualityproducts and Hong Kong Productivity Councilprogrammes can help companies develop theirquality systems.• Quality certification helps ensure qualitystandards within the company and also signalquality to buyers.• Overreliance on a single buyer can result indifficulties for the firm. Thus it is important todiversify the customer base as early as possible.Trade fairs can be useful vehicles for expandingthe customer base.• For many SMEs, senior management needs to beinvolved in the business on a daily basis to ensurethe company keeps moving in the right direction.• Managers should listen to their employees andtalk to them in an open and honest way. Seniormanagers should share their vision with theirteam and discuss openly with them what thecompany needs to do to succeed. This approachcan motivate staff and result in a more pleasantand productive workplace.

55The Consumer Electronics IndustryConsumer electronics refers to any device containingan electronic circuit board that is intended forregular use by individuals. This includes televisions,cameras, digital cameras, PDAs, calculators, VCRs,DVDs, audio devices, headphones, camcorders, andmany other home and office products.Consumer electronics companies engage either inOEM, OBM, or ODM, or a combination of the three.The global consumer electronics industry is mainlydominated by branded companies from Japan,South Korea, Europe, and the US. These companiestypically concentrate research and development intheir home country and place their manufacturingactivities throughout the world, with assembly oftenin the Chinese Mainland.China is one of the world’s largest consumerelectronics manufacturing bases. The 2009 ChinaStatistical Yearbook reports that the “communication,computer, and other electronic equipmentmanufacturing enterprises above designated size” 109in China employed 6.8 million workers, contributeda Gross Industrial Output (GIO) of RMB 4,390billion and value added tax (VAT) payable of RMB61.9 billion in 2008. 110 Electronics production inChina is concentrated in the Pearl River Delta andthe Yangtze River Delta. Guangdong reported thatcommunication, computer, and other electronicequipment manufacturing enterprises in the provinceemployed 2.9 million workers, contributed a GIO ofRMB 1,537 billion and VAT payable of RMB 26 billionin 2008. 111Japanese and South Korean firms have developedglobally recognised brand names on the back oftechnological superiority. Taiwan firms are alsovery active, mostly on an OEM basis. Hong Kongcompanies have leveraged knowledge of markets,customers, technologies, and production locationsin the Chinese Mainland to carve out a positionin the industry. Firms from the Chinese Mainlandare considered to be in the early stages in termsof technology and brand development, but aredeveloping stronger positions and some haveintroduced their own brands into global markets. 112China has been increasing its strength as aproduction location for consumer electronics. Inaddition, the Chinese market is among the fastestgrowing in the world. Industry analysts note thatto a certain extent Hong Kong companies arecaught between the Japanese and Korean firmswho develop their own brands and products on theone hand, and firms from the Chinese Mainland,who have lower costs. In contract manufacturing,Hong Kong firms often face direct competitionfrom much larger Taiwanese companies. However,the electronics market is a large market with manyniches and Hong Kong companies have becomeskilled at supplying such niches. Thus, there appearsto be room for creative Hong Kong companies thatcan find the right niches in the marketplace.Basic Facts about the IndustryThe global consumer electronics industry generatedrevenue of around US$694 billion in 2008 and isexpected to grow at a Compound Annual GrowthRate (CAGR) of around five per cent over theperiod 2010 to 2013. 113 The category that bestrepresents this sector in Hong Kong statistics is“Radio, television and communication equipmentand apparatus.” The GIO for this sector in HongKong was HK$1.1 billion in 2008, employment was1,266, and the estimated average annual wagewas HK$134,281. Wages for the sector in HongKong are four times those for the sector in Chinaas a whole. This is likely explained by general wagedisparities between Hong Kong and China as wellas the employment of more senior staff in HongKong. Wages were approximately 16 per cent oftotal sector costs in Hong Kong. 114109 Enterprise above designated size refers to the enterprise withannual revenue of RMB 5 million or above.110 2009 China Statistical Yearbook.111 2009 Guangdong Statistical Yearbook.112 ESA interviews.113 www.reportlinker.com.114 Hong Kong Census and Statistics Department data on “Radio,television and communication equipment and apparatus,”2009.

56Exhibit 36. Average Monthly Wages for theSector in RMBRegionAverage Monthly WagesHong Kong 9,847YRD 1,856PRD 2,568China 2,493Source: Foshan, Dongguan, Shenzhen, Huizhou, Taizhou (JS), Nantong,Shaoxing, and Jiaxing City Statistical Yearbooks, 2009, China StatisticalYearbook, 2009.115 Hong Kong Census and Statistics DepartmentTotal consumer electronics exports from Hong Kongin 2009 were HK$492.7 billion, or 20 per cent ofHong Kong’s total exports. Total domestic exportswere HK$8.3 billion, a 10 per cent decrease fromthe previous year. Total imports into Hong Kongwere HK$454.3 billion, or 16.9 per cent of totalimports. Total re-exports from Hong Kong wereHK$484.7 billion or 20 per cent of Hong Kong’stotal re-exports. Data for re-exports sourced in theChinese Mainland for the full sector is not availablefor sound recording and reproducers, and televisionimage and sound recorders and reproducers,Chinese Mainland-based processing trade re-exportsthrough Hong Kong were HK$162 billion, MainlandChina based non-processing trade re-exports wereHK$64 billion, and total re-exports originating fromthe Mainland were HK$226.2 billion or 9.3 per centof total re-exports. 115Exhibit 37. Consumer Electronics Exports from Hong Kong, HK$ millions2007 2008 2009Destinations Value Y-o-Y Change Value Y-o-Y Change Value Y-o-Y ChangeWorld 506,637 13.6% 551,023 8.8% 492,699 -10.6%Chinese Mainland 185,760 26.6% 197,035 6.1% 176,577 -10.4%US 58,698 4.3% 57,866 -1.4% 51,363 -11.2%Japan 26,379 38.4% 28,392 7.6% 27,464 -3.3%Source: Hong Kong Census and Statistics Department.Exhibit 38. Consumer Electronics Re-exported from Hong Kong, HK$ millions2007 2008 2009Total Value Y-o-Y Growth Value Y-o-Y Growth Value Y-o-Y GrowthWorld 497,964 16.5% 541,779 8.8% 484,666 -10.5%Source: Hong Kong Census and Statistics Department.Exhibit 39. Consumer Electronics Imports to Hong Kong, HK$ millions2007 2008 2009Origin Value Y-o-Y Change Value Y-o-Y Change Value Y-o-Y ChangeWorld 459,782 11.4% 499,043 8.5% 454,272 -9.0%Chinese Mainland 259,860 17.1% 275,162 5.9% 246,478 -10.4%Japan 35,006 14.3% 37,903 8.3% 31,291 -17.4%Taiwan 17,128 17.2% 14,822 -13.5% 11,599 -21.7%Source: Hong Kong Census and Statistics Department.

57Issues for Hong Kong Consumer ElectronicsManufacturersHong Kong consumer electronics manufacturingfirms operating in the PRD are facing major issuesincluding rising operating costs, a shortage ofskilled workers, appreciation of the RMB againstthe US dollar, pricing pressure from customers amidthe downturn of the global economy during theyear, and an inability to compete with MainlandChinese firms purely on the basis of productioncosts. Competing in China’s domestic marketis difficult due to the fragmented nature of themarket, the relatively low purchasing power ofmost of the population in Mainland China, shiftingregulations, policies that have historically seemed tofavour domestic Mainland China firms in the sectorrather than Hong Kong companies or joint venturecompanies, and the evolving nature of the market.The electronics industry was one of the hardesthit sectors during the 2008 financial crisis but thereviving global economy has stimulated the marketdemand for consumer electronics, and electronicproduct exports in Hong Kong in the first quarterof 2010 reported an 18.4 per cent increase yearon-year.In December 2009, a survey by theHKTDC reported that the consumer electronicssector is expected to see a stronger rebound thanmost other sectors. An assessment released byHKTDC on 29 January 2010 116 shows a majority ofexporters holding a neutral view (40 per cent) andan optimistic view (51 per cent) on prospects for theglobal consumer electronics industry. In spite of thedifficulties that they faced, most Hong Kong firms inthe electronics industry survived the crisis, althoughmany of them experienced a decline in profit or amove into loss-making territory. 117 In the first twomonths in 2009, the overall profit of the electronicsindustry in China decreased 96.3 per cent year-onyear.118National and local industrial policies show adetermination by the central and local governmentsin China to upgrade the sector. Electronicinformation and technology is one of the eightinnovative and high technology areas that theChinese Government in Mainland China supports. 119Firms in the eight technology areas will be givenfavourable tax treatment. These policies favourMainland Chinese firms and will make it harder forHong Kong owned manufacturers to compete.In April 2009, the Chinese Government published a“Plan on Adjusting and Revitalising the Electronicsand Information Industry” (2009-2011) tostimulate the development of the electronics andinformation industry, to speed up its restructuring,and to upgrade the sector. The main measuresof the plan include expanding the coverage oftelecommunication, broadcast, and televisioninfrastructure in China’s rural area to support thedevelopment of photovoltaic power generation,and to promote LED lighting products. HongKong manufacturing SMEs will be forced to makecorresponding changes to keep pace with thisnational strategy.116 See Hong Kong Trade Development Council, “On the Roadto Recovery: Assessment of 2009 Christmas Sales in MajorMarkets,” 29 January 2010.117 ESA interviews.118 www.pcbcity.com.cn.119 The Catalogue of the Innovative and High TechnologyAreas with the Government’s Primary Support, Appendix ofMeasures for Administration of Recognition of Innovativeand High-Tech Enterprises, ( Guokefahuo [2008] no. 172).

58The Guangdong Government also published its own“Plan on Adjusting and Revitalising the Electronicsand Information Industry” in November 2009. 120The Plan focuses on industrial restructuring andupgrading, and governmental support is focusedon pillar sectors, leading enterprises, and thedevelopment of self-owned technology and brands.Further, the timeframe for the “home appliance andmotor vehicles to the countryside” and the “motorvehicle and home appliance replacement” policieshave been further extended. 121These policiescategorise certain consumer electronic productssuch as televisions and telephones as homeappliances and eligible for support. These policieswill stimulate the demand in China for consumerelectronics and Hong Kong firms will want to bepositioned to take advantage.Labour issues are compounded by the fact thatconsumer electronics manufacturing requiresa large number of skilled technicians and thenumber of migrant workers looking for work inthe PRD, especially skilled technicians, has fallensince 2008. The Labour Contract Law will increasemanufacturing costs because of the requirementthat firms provide additional worker benefits. Thiswill have the greatest impact on labour intensiveindustries, meaning that the effect on the consumerelectronics sector is likely to be less pronouncedthan on many others, 122 but firms will still need tocover any additional cost and they will need to be ina position to source skilled workers on an ongoingbasis.120 www.uschina.org.121 The initial “Home appliance replacement” policy expired on31 May 2010 and has been extended until 31 December 2011.122 China Statistical Yearbook 2009, calculated ratio of GIO toEmployment.123 Ministry of Commerce, 2007124 The opinions on general planning and management forthe highly polluting industries such as electroplating,printing, and dyeing”, Guangdong Environmental ProtectionDepartment, 2008125 Interview with the Hong Kong Electronics Industry Council,14 April 2010.The consumer electronics sector does not haveany export processing restrictions directly imposedon it but the supply chain for non ferrous metalsis affected by restrictions on copper, aluminium,nickel, tin, and zinc products. 123 The export rebatefor the sector did not change in 2007 or since. Theupstream electroplating of components and themanufacture of circuit boards used in the sectorare polluting activities that are under close scrutinyand control, and are being restricted. In 2008, theGuangdong Environmental Protection Bureau issueda plan 124 to consolidate all electroplating factoriesto purpose-built parks with their own centralisedwater purifying centres so that all discharges can becontrolled. Factories that fail to move will be closeddown. These activities have the potential to disruptthe sector by disrupting the supply chain.Response Strategies of Hong Kong SMEsHong Kong electronics firms understand thatcompetition in the industry is cost-based to an extentand that cost increases must be managed throughimproved operating efficiencies, but the precision thatis required in doing the manufacturing means that itis a combination of price, quality, and performancethat actually determines which firms get orders andwhich firms do not. Most successful Hong Kongfirms are committed to doing well across all of theseattributes in order to cope with competition fromboth Chinese firms at the low-end and Japanese,Korean, and Taiwan firms at the higher-end. 125Many Hong Kong electronics firms do theirmanufacturing in Guangdong which is cheaperthan doing it in Hong Kong, but more expensivethan manufacturing in some other parts of China.However, as these firms point out, making productsin Guangdong means that the end product is stillrelatively high in quality, so some firms in the sectorhave for the time being strategically accepted apresence in Guangdong as being a necessary tradeoffnoting that controlling cost is only one issue thatneeds to be managed. In response to the economicdownturn, many firms in the electronics industrytried to cut costs by reducing production or bylaying off workers.

59Some Hong Kong owned firms have addressedthe labour issue by providing benefits that areattractive to workers in the PRD and which areabove those being provided by competing firms.Firms that view this as not feasible or as being atemporary solution to the problem have relocatedor will consider relocating their operations to anarea where labour is less costly and more abundant,such as the Northern part of the PRD, the YRD,or China’s interior. Relocation within MainlandChina is becoming an option for some firms in thesector, and it will become a more attractive optionif the trend of larger companies moving to partsof Mainland China other than the core of the PRDcontinues.Although some other countries including Vietnamand Indonesia offer low-cost manufacturingenvironments, most firms in the sector currentlyfeel that it is would be premature for them tomove there because those locations currently lackthe infrastructure that is needed to support thebusiness that an SME in the consumer electronicssector would need to run. For instance, if a HongKong owned SME set up an electronics factory ina location that does not have a critical mass in allthe segments in the value chain, then the companywould need to buy all the materials in Hong Kong,package and ship them to the other location,produce the products, and ship the products backto Hong Kong. The only real advantage in settingup in a low-cost location would be to access lowcostlabour and most firms agree that chasing lowcostlabour is not a sustainable long-term strategy.Some Hong Kong firms have attempted todifferentiate themselves by innovating throughbetter design, better technology, or throughbranding, so as to expand to do ODM or OBM.Some are developing new niches, such as greenmanufacturing opportunities in LED lighting andelectric vehicles.Some Hong Kong SMEs have turned their attentionto the Chinese Mainland market, though manythat are finding it difficult to compete in China’sdomestic market have opted not to do so for now,continuing to focus instead on supplying to marketsoutside of the Chinese Mainland where the firm cancompete more effectively.Case Study – Suga Holdings LimitedSuga International Holdings Limited (Suga) wasfounded in 1991 and is headquartered in HongKong. Suga is an Electronics ManufacturingServices (EMS) provider offering Original EquipmentManufacturing (OEM) and Original DesignManufacturing (ODM) solutions.In 1992, Suga commenced manufacturingoperations in Huizhou in Guangdong Province.The business grew rapidly and in 1994 anothermanufacturing base was set up in Shenzhen, whichwas further expanded in 1999 and in 2005. In2002, Suga set up a third manufacturing base, oncemore in Shenzhen. Suga was listed on the mainboard of the Hong Kong Stock Exchange in 2002.Suga has made its name as a manufacturer ofniche products that have gone on to become verysuccessful. This includes a series of interactiveeducation products (since 2003) and specialisedprofessional audio products (since 2006).Beginning with just seven staff including the founderMr Ng, Suga has approximately 2000 employees.The firm started with a relatively small investmentof HK$2 million. Suga has experienced substantialgrowth since then and has won wide recognitionfrom both clients and third party agencies for itsconsistent quality and excellent management.Except for some high-end corporate managementactivities including a portion of its research anddevelopment, all of Suga’s main activities arelocated in China.

60Suga’s sales in the 2010 fiscal year were HK$959million, with electronic products accounting for 95.6per cent of sales, and moulds and plastic productsaccounting for 4.4 per cent. Total sales increased by18.1 per cent from 2009 to 2010. Suga’s revenueis derived fairly evenly from the US, the Asia Pacificregion (including China), and Europe. China iscurrently a relatively small market and it is hopedthat during the next few years the China marketwill grow at a fast rate.Issues and ChallengesBeing a listed company puts Suga into the spotlight.This adds to the competitive pressure that Sugahas to deal with and means that Suga pays closeattention to its competitive environment. However,Suga doesn’t have too many competitors because itspecialises in selling niche products in most markets.The exception is in Japan where the company hasseveral competitors.Suga has had to work hard to establish trustbetween the company and its customers in orderto secure business and develop it. Mr Ng notes that“even though Suga’s price is higher than manyof its competitors, Suga is competitive once theprice/performance ratio is taken into account. It isthat ratio that is most important for the customerbecause if you offer them low price but you havelow quality it is not an efficient trade-off for them.”Mr Ng relates that the major challenge thatSuga has faced over the long-term is the needto continually innovate. He makes the point thatinnovation is hard, but that to remain successfulas a producer of niche products it is an essentialelement. Suga has to constantly find innovativepeople who come up with innovative ideas. Italso needs to frequently revisit the firm’s businessmodel to match it up with changes in the businessenvironment.Constantly striving to innovate means that there willbe failures as well as successes. Mr Ng cites Suga’sforay into OBM in the digital audio business as onefailed initiative. This was in part due to inexperiencein managing a brand and in doing retailing, in partdue to the cost involved in trying to build a brand,and in part it was because of differences in brandingat an industry level. On this latter point, Mr Ngsuggests that for many products, such as garments,branding is pivotal to success for a greaterproportion of companies in the industry. He thinksthat this is because fundamentally there is actuallynot too much of a difference between many of theproducts. With reference to garments, for instance,one shirt is very much like another and technologydoes not play a big part in manufacturing the shirtor in differentiating it from other shirts. This makesbranding important to success for many companiesin that industry and it means that it is worthwhilespending the money that is required to build abrand. This is not the case for most firms in theconsumer electronics sector, however.The challenge for Suga has been to focus onthe right technologies and to leverage off itstechnological capability to capture an attractiveprofit margin. This technology-led edge createsthe challenge of dealing with complexity. Suga’sproducts require technology and engineeringsupport at a fairly high level. Also, Suga hasautomated operations where possible and this addsto the cost and complexity of running the business.Figuring out when to make a big push into thedomestic market in China is another issue for Suga.Many firms are looking to compete in China’s fastgrowingdomestic market, but Mr Ng makes thepoint that benchmarking the whole of consumerconsumption for Mainland China against that in theUS or in Europe reveals China to be a small marketat present. Thus he feels that any move to try andreplace existing markets in the US, Europe, andJapan, with the market in Mainland China would bepremature.

61Suga has occasionally been challenged by theshortage of labour in Mainland China and thecompany is affected when the cost of employmentincreases. The relatively low level of labour intensityin the industry makes this a lower order issue thansome others, however.The recent financial crisis was an issue for Suga, butless so than for many other firms in the consumerelectronics sector, largely due to the nature of itsproducts. Mr Ng admits that Suga’s gross profitmargin was down a bit from 13.1 per cent in fiscalyear 2008 to 11.9 per cent in fiscal year 2009.Overall, however, in terms of production, orders,and share price, the firm’s performance was prettygood and the firm was growing. Revenues fromJapanese customers were down the most becausethey focus more on the consumer products. Butthe economic downturn did not hit the educationproducts, it only slightly hit the pet products, anddemand for the professional audio products evengrew during the economic downturn.Suga’s factories are located in relatively expensiveareas. Cost increases need to be covered by thebusiness and when they frequently occur there is aneed to pass the costs along to the customer, whichis sometimes difficult.Suga has had to deal with a major and unexpectedloss of business on several occasions. Early in Suga’sdevelopment the company’s first customer ran intodifficulty and significantly cut the orders that theyplaced with Suga at a time when Suga was trying togrow and diversify its revenue streams, but before ithad managed to do so. On another occasion, one ofSuga’s customers started to do so well with Suga’shelp that they were acquired by a large companythat then decided to take the business that hadpreviously been given to Suga in-house. Mr Ngnotes that “even excellence in a specialised field orniche area may not make the company successful,or even if we are doing well the result may not bethat satisfactory.” The opposite situation sometimesoccurs with Suga finding that a rush of ordersstretches its existing capacity.Hong Kong’s regulatory system is simple,transparent, and the regulations are applied fairly.Things are quite different in China where there aremore regulations, the regulations change often,they are less clear and therefore pose a greateradministrative burden, and there is less certainty asto the purpose and direction of the regulations. Theregulatory environment in China requires that Sugaplace some senior executive staff in China whoknow how to deal with the system and with thegovernment officials there.Company StrategySuga leveraged a small amount of start-up capitalvery well to create a relatively large scale capacityto do manufacturing. Suga did this through“Chengbao”, meaning that Suga effectively leaseda portion of another factory’s production capacity,using the money that it otherwise would have spentin trying to establish a small production facility ofits own. This arrangement lasted for a few yearsuntil Suga attained a size and scale that enabled thecompany to set up its own factory in 1994. If notfor the Chengbao arrangement, this probably wouldhave taken much longer, if it happened at all. Goodfinancial management, including the maintenanceof strategic cash buffers at the bank along withconsiderable banking facilities, has served Sugawell, giving it great flexibility in pursuing businessexpansion if it so desires.Suga does not aim to be a low cost manufacturerbut Mr Ng thinks that maintaining Suga’smanufacturing base in Mainland China will keepthe company competitive, as will the continuedautomation of firm processes that are labourintensive.

62What really differentiates Suga is its focus onspecialised products. These products are notas vulnerable to market fluctuation as generalproducts, and they tend to have a higher profitmargin than general products. By being the leadingmanufacturer of a niche product, Suga becomesmore important to the customers that havedeveloped the markets for those products. This fact,and the investment that is made in developing thespecialised technology, creates barriers to entry inSuga’s markets which means that other companieswould find it harder to compete with Suga. It alsomeans that Suga grows alongside its customers,scaling up in a way that is more measured andlower in risk than if Suga had to add capacity andpunt on where demand might come from. In 2009,specialised products represented 60 per cent ofSuga’s output.Suga’s success is reflected in its Chinese companyname which means the “best integrity.”Adherence to this characteristic played a pivotalrole in Suga’s early success. In 1992, Mr Ng made abusiness pitch to a large Japanese customer whenSuga was small. At that time, the large Japanesecustomer had a new product, the LCD TV, andthey were looking for manufacturers. When Mr Ngmet with the large Japanese customer, the seniorexecutives asked him about his relevant experienceand he commented that he had none in makingLCD televisions, but that the company had otherrelevant experience, was willing to learn, andwould welcome the opportunity to work withthe large Japanese customer and to receive earlysupport from them including instruction as tohow they would like the product to be assembled.Somewhat unexpectedly, the large Japanesecustomer gave Suga the contract even thoughSuga was the smallest bidder. The large Japanesecustomer executives informed Mr Ng that theapproach taken by all the other companies thatthey met with was to say “oh we can do it, noproblem, it’s easy” and the decision was taken togive the work to Suga because Suga was honestand upfront when others were not. Today thelarge Japanese customer is still Suga’s customerand on the back of the commitment made to Sugaby the large Japanese customer, as well as Suga’sperformance for the large Japanese customer,the firm managed to take on a total of three bigJapanese customers in a relatively short periodof time. This spearheaded Suga’s fast growth inbusiness.An unintended positive consequence of managingto secure a few large Japanese companies ascustomers is that they have loyally supported Sugaduring a couple of tough periods by doing thingslike arranging letters of credit for the companyto use to finance its operation during the shortterm.With a letter of credit from a major Japanesecompany, Suga is able to continue to get bankfinancing so that materials could be purchasedwhen needed, for instance.Mr Ng also attributes Suga’s success to theinvestments it has made in developing a world-classERP system and in automating whenever possible.These moves have improved Suga’s manufacturingand operating efficiency, as well as the quality andtimeliness of its management decision-making.To exploit the competitive advantage that comesfrom technological superiority, and to put Suga in aposition of being able to innovate, Suga maintains aleading-edge capability in specialised technology byensuring that its research and development team iswell-trained and that its skills are regularly updated.This includes having the research and developmentteam participate in product developmentcompetitions.Planning is important to Suga, as is the setting of3-to-5-year strategies which are reviewed annually.Monthly planning and review meetings are heldwith the senior management team and during thosemeetings there is an opportunity for cross-functionalcollaboration between business units that otherwisemight not have a structured environment in whichto share ideas. The important discussions that takeplace between the marketing and engineeringteams, for example, sometimes improve newtechnology to make it more attractive to the market.

63In terms of dealing with regulatory issues, Sugatakes its regulatory responsibilities very seriously.Compliance is essential to having a strong business,and Suga ensures that its actions are geared toworld’s best practice in all of the markets in which itoperates. By way of example, even when Suga wasvery small it used one of the big global accountingfirms as its auditor.Suga’s response to the loss of a couple of keycustomers early in the life of the company was totarget several large Japanese companies with areputation for excellence in quality, a track recordof doing business over the long-term with contractmanufacturing companies, and existing customermarkets of significant size, thus creating more stabledemand for Suga’s products. Following successin developing relationships with target Japaneseclients, Suga then worked to geographicallydiversify its customer base to protect the companyagainst a shock emanating from any one country.This strategy paid off when Suga felt the effects ofthe economic downturn far less than many of itscompetitors. Diversification at the product level hasalso proven a good strategy; as the revenue fromthe general consumer electronic products which aremore sensitive to the global economic downturnhas declined, Suga has reallocated resources tosupport niche products with higher margins.To control for unexpected spikes in demand Sugaalso maintains good relationships with other firmsin the industry and has manufacturing partners thatSuga can work with in the event that a flurry oforders arrives. This gives the firm greater flexibility.Finally, Mr Ng explains the importance of teamworkin solving the company’s problems and in helping itto overcome the many challenges that confront it.Mr Ng’s view is that employees should be treated aspartners in the business and that the same respectand loyalty should be shown to them that onewould show to one’s family. Mr Ng believes that“this will lead the workers to do their best for thecompany” thereby making it better able to compete.Future PlansSuga plans to continue focusing on high marginbusinesses in niche markets including pet trainingdevices, interactive educational products, andelectronic ticket processors, among others. Sugais also trying to tap into other markets with greatpotential, including those for WIFI products andhealth care products. It is hoped that the companywill develop so that each of the subsidiariesbecomes a leader in its specialised area.Mr Ng is considering what form the company musttake in order to maximise its growth. He thinks thatfor the firm to grow it cannot position itself purelyas a manufacturing company without strategicintent, it must be able to differentiate in someway and it must be able to transform to fit futurebusiness environments. For example, with the recentfocus on environmental issues, Suga has decidedto explore the opportunity to develop LED lightingfor use in the image projection business in a waythat would reduce the size of current projectionequipment and save energy.Hong Kong will remain as the location of Suga’sheadquarters and production will stay in MainlandChina. Suga will continue to look for opportunitiesto forge strategic alliances with overseas marketingexperts with the aim of securing more overseascustomers through such alliances. Looking ten yearsahead, Suga aims to be diversified geographically tothe point that it has a quarter of its annual sales ineach of the US, Europe, Japan, and China.Mr Ng plans to remain in his present role forsome time yet and he does not currently have asuccession plan. He explains that Suga has a teamof professional managers who are well qualified torun the company if there were ever the need.

64Lessons from the Suga Holdings CaseThere are a number of lessons that can be learnedfrom the Suga case.• SMEs should focus on specialised products.These products are not as vulnerable to marketfluctuation as general products, and they tendto have a higher profit margin than generalproducts.• By being the leading manufacturer of a nicheproduct, the SME becomes more important tothe customers that have developed the endmarkets for those products. This creates barriersto entry which mean that other companies wouldfind it harder to compete with the firm.• SMEs that specialise in selling niche products arelikely to have fewer competitors.• The price/performance ratio is most important forthe customer because low price but low quality isnot an efficient trade-off.• SMEs need to continually innovate. Innovationis difficult but to remain successful it is essential.This means finding innovative people anddeveloping innovative ideas is important.• Striving to innovate means that there will befailures as well as successes.• SMEs should ensure that their business modelmatches the business environment.• To avoid problems from an overreliance on onelarge customer, SMEs should develop a customerbase with a diverse geographical and productmix.• SMEs in this sector need to carefully considerwhether it is worth spending the money that isrequired to build a brand.• SMEs can leverage off their technologicalcapability to capture an attractive profit margin.• SMEs in the sector operate in a complexenvironment that requires technology andengineering support at a fairly high level.• Firms will need to automate operations wherepossible. This adds to the cost and complexity ofrunning the business.• China’s domestic market is fast-growing butcomparatively small and not yet very attractive.Thus any move to try and replace existingmarkets in the US, Europe, and Japan, with themarket in Mainland China being premature.• Cost increases need to be covered by thebusiness and when they frequently occur there isa need to pass the costs along to the customer,which is sometimes difficult.• Customers and competitors won’t wait for afirm to put its strategy in place. Firms needto constantly revisit their strategies and thinkthrough the various scenarios that might affecttheir business and plan on how to respond tothem.• Excellence in a specialised field or niche area maynot be enough to make the firm successful.• Spikes and troughs in demand occur and plansshould be in place to deal with them.• Hong Kong’s regulatory system is simpler andmore transparent than China’s. Firms may needsenior staff in China who know how to deal withthe system there.• SMEs must take their regulatory responsibilitiesvery seriously. It is unlikely that being small in sizewill be accepted as a reason for regulatory noncompliance.• SMEs should benchmark their activities againstworld’s best practice.• SMEs can and should think and act like big firms.They should consider using globally recognisedprofessional services firms. They will benefit fromputting world-class management performancesystems in place.• SMEs don’t need a lot of start-up capital. Theycan scale capacity by leasing a portion of anotherfactory’s production capacity. The money savedby not immediately buying a factory can be spentin marketing and developing the business.• Good financial management is important toSMEs. This includes the maintenance of strategiccash buffers, and the establishment of bankingfacilities.

65• Having a manufacturing base in Mainland Chinamay make the SME more competitive, as will thecontinued automation of firm processes that arelabour intensive.• Creating loyal customers will pay back duringtough times. Loyal companies may do things likearrange letters of credit for the firm to use tofinance its operation during the short-term.• SMEs must work to understand the needs oftheir partners as well as their customers.• SMEs can develop and maintain a technologicaladvantage by ensuring that their research anddevelopment team is well-trained and thatits skills are regularly updated. Research anddevelopment staff need to be motivated andincentivised just like other staff. Motivationcan come in many forms including throughparticipation in competitions.• SMEs need to plan. They should set strategiesand review them regularly.• Meetings with the senior management teampresent an opportunity for cross-functionalcollaboration between different business units.Such collaborations have the potential to bringabout material improvements in the business.• Teamwork is important. To create a strong team,the firm should treat employees as partners in thebusiness and that the same respect and loyaltyshould be shown to them that one would showto one’s family.• Failure can be a lesson on how the firm canimprove. Although a short-term problem mayaffect short-term profit, a lesson well learned mayhave a greater positive impact on long-term profit.• Focusing on the short-term is often the wrongthing to do. Many of the problems that firmsface are due to attempts to maximise profit ona short-term basis. This can lead to disharmonywith staff, customers, and other importantstakeholders that the business depends on for itslong-term success.• Integrity and reputation are all-important tosuccess in the industry. Both qualities are hardwon and, if lost, are even harder to regain.The Garment IndustryThe garment industry consists of fashion design,apparel manufacturing, clothes wholesale, andretailing. The global garment industry’s totalrevenue in 2006 was US$1,253 billion. This isestimated to reach a value of US$1,782 billion bythe end of 2010. 126China is the largest producer and consumer ofgarments, producing over 50 per cent of the world’stotal in 2008. Guangdong Province is the largestgarment producer in China, accounting for 18.3 percent of total reported Gross Industrial Output (GIO)in garments in China in 2008 (ahead of Zhejiang,Jiangsu, Shandong, and Fujian). It is reportedthat there are over 30,000 garment enterprises inGuangdong in 2009 and about 80 per cent of theseenterprises are mainly export-oriented. 127 The 2009Guangdong Statistical Yearbook reports that thegarment sector in Guangdong accounted for 1.1million workers, GIO of RMB 172.5 billion, exportsof US$23.9 billion, imports of US$823.5 million,and VAT of RMB 5.6 billion in 2008. Garmentmanufacturing is concentrated in the PRD, especiallyin Dongguan, Zhongshan, and Foshan.Hong Kong firms are a leading global force in theindustry. Several of the world’s leading garmentfirms are headquartered in Hong Kong and it hasbeen estimated that Hong Kong firms control onthe order of a quarter or more of world garmenttrade. Hong Kong companies generally look afterstrategy, coordination, marketing, and financefrom Hong Kong, while producing in the Pearl RiverDelta and elsewhere. Hong Kong companies startedmoving production into the PRD in the 1980s andlittle production remains in Hong Kong. The vastmajority of Hong Kong garment companies, largeas well as small, are engaged in OEM productionfor well-known brands and retailers such as Armani,126 www.fashionproducts.com.127 gcontent.nddaily.com.

66Hugo Boss, and Banana Republic. Hong Kongcompanies have benefited from Hong Kong’sopenness, managerial skills, financial sector,international linkages, transportation system, andcommunications infrastructure, while offsettingdisadvantages in labour and other costs by shiftingproduction into the Chinese Mainland.The end of the global garment quota system inJanuary 2005 led to a tremendous spike in HongKong’s garment re-exports from China in thefirst six months of 2005. Since then, the globalgarment trade has steadied, with China’s sharesignificantly higher than before. Hong Kong andother international garment exporters have investedheavily in capacity in the Chinese Mainland.Some developing countries such as Bangladesh,India, Vietnam, Cambodia, and Thailand aregrowing their low-end garment industry. Thesecountries have lower operating costs than China.Some garment companies in the PRD haveconsidered moving their manufacturing factoriesto one or more of these countries, though fewhave done so to date. While industry participantsexpect that South Asia in particular will becomea larger player in the low end segments of theindustry, and that even Africa may become amore significant producer, China will remain thedominant production location in the garmentindustry for the foreseeable future. Thus it is key forHong Kong firms to be able to continue to leverageChinese production locations, and to competeagainst competitors from the Mainland if they areto succeed. While companies that are not ableto distinguish themselves in terms of technology,design, flexibility, reliability, and quality will face atough time, there are enough Hong Kong firms thatdo distinguish themselves on one or more of thesedimensions to indicate that Hong Kong will retain astrong position in the industry.Basic Facts about the IndustryGIO and employment in the garment sector in HongKong decreased from HK$23 billion and 24,000people in 2004 to HK$8 billion and 13,000 peoplein 2008. 128 Average wages for the garment sectorin Hong Kong are six times those for wages in thesector for China as a whole. This is likely explainedby general wage disparities between Hong Kongand China, the employment of more senior staffin Hong Kong, and the fact that higher value endproducts are produced in the sector in Hong Kongwith corresponding higher quality and more costlylabour inputs. Wages were approximately 23 percent of total costs for the sector.Exhibit 40. Average Monthly Wages for theSector in RMBRegionAverage Monthly WagesHong Kong 9,034YRD 1,605PRD 1,710China 1,559Source: Foshan, Dongguan, Shenzhen, Huizhou, Taizhou (JS), Nantong, Shaoxing,and Jiaxing City Statistical Yearbooks, 2009, China Statistical Yearbook, 2009.The total exports from Hong Kong for the textileand clothing sector in 2009 were HK$254.5 billionor 10.4 per cent of total exports. Total domesticgarment exports for Hong Kong were HK$4.4billion, a decrease of 80 per cent from the previousyear. Re-exports from Hong Kong for the textile andclothing sector were HK$247.8 billion or 10.3 percent of total re-exports. Mainland based processingtrade re-exports through Hong Kong accountedfor HK$118.4 billion of this total, while Mainlandbased non-processing trade accounted for a furtherHK$45.6 billion. Total re-exports originating fromthe Chinese Mainland were HK$164 billion or 6.8per cent of Hong Kong’s total re-exports, and 66 percent of garment re-exports. 129128 Hong Kong Census and Statistics Department.129 Hong Kong Census and Statistics Department.

67Exhibit 41. Textiles and Clothing Exports from Hong Kong, HK$ millionsDestinations2007 2008 2009Value Y-o-Y Growth Value Y-o-Y Growth Value Y-o-Y GrowthWorld 329,269 0.1% 313,024 -4.9% 254,532 -18.7%US 83,925 1.3% 77,383 -7.8% 63,083 -18.5%Germany 16,674 5.7% 18,148 8.8% 15,384 -15.2%UK 24,092 5.7% 23,811 -1.2% 18,722 -21.4%Source: Hong Kong Census and Statistics Department.Exhibit 42. Textiles and Clothing Re-exported from Hong Kong, HK$ millionsDestinations2007 2008 2009Value Y-o-Y Change Value Y-o-Y Change Value Y-o-Y ChangeWorld 286,772 5.2% 287,611 0.3% 247,881 -13.8%US 68,562 10.7% 66,037 -3.7% 61,517 -6.8%UK 19,749 13.3% 22,578 14.3% 18,400 -18.5%Germany 14,376 20.6% 17,366 20.8% 15,281 -12.0%Source: Hong Kong Census and Statistics Department.Exhibit 43. Chinese Mainland Process Industry Garments Re-exported from Hong Kong, HK$ millionsHong Kong’s Garments Re-exports of the Export Processing Products Manufacturedin the Chinese Mainland2006 2007 2008 2009Value 125,952 141,669 135,230 118,446Source: Hong Kong Census and Statistics Department.Exhibit 44. Textiles and Clothing Imports to Hong Kong, HK$ millionsOrigins2007 2008 2009Value Y-o-Y Change Value Y-o-Y Change Value Y-o-Y ChangeWorld 255,439 0.0% 240,646 -5.8% 197,740 -17.8%Mainland China 135,343 1.0% 128,247 -5.2% 106,932 -16.6%Italy 18,863 1.2% 17,762 -6.2% 15,027 -18.2%Source: Hong Kong Census and Statistics Department.

68In 2009, Hong Kong imported textile and clothingsector traded goods of HK$197.7 billion or 7.3 percent of total imports. This was down 17.8 per centfrom 2008.Issues for Hong Kong Garment ManufacturersThe major issues facing Hong Kong garment firmsoperating in the PRD are rising operating costs, ashortage of skilled workers, a decrease in ordersfrom overseas buyers, competition from otherdeveloping countries, increased order frequency,reduced individual order volume, changing styles,a demand for speedier delivery, higher qualitydemands from end customers, and the appreciationin the RMB. Competition in the garment industrywithin China and between China and otherlocations is intensified by low entry barriers.The impact of the global economic slowdown canbe seen in that Chinese Customs reported that thegarment exports from China fell by 9.8 per cent fromUS$185.3 billion in 2008 to US$167.1 billion in 2009.Hong Kong’s garment business was greatly affectedby the downturn, with total exports, total imports,and re-exports of textiles and clothing seeing doubledigit declines in 2009. China’s garment exportsstarted to grow again during the latter part of 2009.However, retailers’ confidence remained fragile,and they have been reducing their working capitalby placing smaller order volumes and demandingquicker delivery times at cheaper prices. 130130 “HK exporters in Pearl River Delta win more orders,” SouthChina Morning Post, 27 May 2009.131 english.tianhechem.com.132 Interview with the leadership of Federation of Hong KongIndustries, 31 March 2010.The garment industry is labour-intensive. Thismeans that it is hit disproportionately by increasesin labour costs in China and is more subject tocompetition from low wage nations than othersectors. China has had a labour cost advantagethat helped it compete in the industry. Increasingly,however, lower labour costs can be found in otherdeveloping nations, though China still benefits frommassive scale, a huge home market, and establishedgarment and textile production chains.In addition, there is a shortage of skilled workersin the sector in the PRD. The manpower shortageacross the economy in areas such as Guangzhou,Shenzhen, and Zhuhai was estimated at morethan two million in early 2010, 131 forcing garmentfactories to reduce production. The GuangdongLabour and Social Security Bureau increased theminimum wage effective from 1 May 2010. Mostof the Hong Kong factory owners we interviewedthought the new measure would be of little helpin attracting more migrant workers as manymanufacturers still face labour shortages even afterpaying their employees more than the amountthat the government requires. 132 Further, increasesin labour costs have a significant impact onprofitability and even the viability of the business,and on the competitiveness of the PRD in theindustry.The garment industry was one of the industriessingled out for greater restrictions on exportprocessing and reduced VAT rebates in China in2006 and 2007 on the grounds that the garmentindustry was too labour and resource intensive. Thedyeing sector, a key component of the garmentsector, has been singled out as a polluting industrythat also requires restrictions. This has the potentialto disrupt a key step in the supply chain.

69China’s Labour Contract Law is not differentiallyapplicable at an industry level, but it is clear that thenew law will increase manufacturing costs becauseof the requirement that firms provide additionalworker benefits. This will have the greatest impacton labour intensive industries, meaning that theeffect on the garment sector is likely to be morepronounced than on many others. 133At the end of 2008 the State Council introduceda “Plan on Adjusting and Revitalising the Textilesand Garment Industry” to help the Chinesegarment industry to overcome the global economicdownturn. 134 This Plan has helped the industry inMainland China raise finances and improve theirtechnological capabilities. Raising the tax rebaterate for textile exports, providing subsidies, andpostponing social insurance payments has improvedthe textile companies’ cash flows.The NDRC Plan for the PRD and related policies haveput pressure on garment firms, particularly thosethat do contract manufacturing, to move elsewherein Guangdong, move out of Guangdong altogether,and/ or move into ODM and OBM as a means ofadding greater value. The Guangdong Governmentintroduced a “double-transfer initiative” in 2008 135to encourage companies in the Pearl River Deltaregion to relocate their labour-intensive productionfacilities to less developed regions in the East, West,and North of the Province where there is readilyavailable local labour.The relocation of a garment factory is less difficultthan other industries due to the simple natureof the machinery and production processesinvolved. Their requirement for local servicesis also lower than other industries and theirsimpler supply chain means that may not also benecessary to move their upstream suppliers aswell. Nevertheless, the garment industry has along processing and supply chain where the PRDstill has advantages. The PRD can provide fast andreliable delivery for garments products as it hasestablished a very good supply chain and flexibleservices system. The logistics costs will increaseif the garment factories move outside of thegarment manufacturing cluster.While Hong Kong firms’ ability to manageproduction in South China is still an advantage,competition with other areas of China will heat up.There will be challenges associated with movingproduction into new areas of China. Moving deeperinto China’s interior dilutes executive control fromHong Kong. It also may bring executives into moredirect competition with strong local manufacturers,and require them to deal with local governmentsless aligned with their export oriented activities.In addition, international sourcing operationstraditionally focused on Hong Kong and the PearlRiver Delta will diversify their supply locations inChina.Response Strategies of Hong Kong SMEsThe sharp decline in Hong Kong domestic garmentexports suggests that the industry in Hong Kongsuffered greater losses than in many other locationsas a result of the global economic crisis and it mayalso point to an acceleration of moves by remainingfirms to relocate garment manufacturing to theChinese Mainland. For firms already in the PRD,moving to less developed parts of Guangdongmay reduce labour costs and allow them to findsemi-skilled workers, but may impose difficultiesin finding and retaining skilled technicians andmanagement, as well as increase supply costs andthe cost of shipping finished products.133 China Statistical Yearbook 2009, calculated ratio of GIO toEmployment134 www.lawinfochina.com.135 www.newsgd.com.

70The end of the international garment quota systemhas changed the industry’s competitive landscape.One major impact was competition on price ratherthan on quota. Several Hong Kong firms that hadset up production in multiple locations (or at leastin locations other than Hong Kong or the ChineseMainland) to get around quota restrictions focusedtheir production more and more in the PRD andYRD. With recent cost and regulatory changes inChina, however, some have started opening newfacilities in interior provinces. Others have opened orconsidered facilities in Vietnam, Bangladesh, India,and other countries. Still others have supplementedor even replaced their own production activitieswith outsourced production. In more extreme cases,companies have shifted from manufacturing tosourcing and trading.Another impact of the end of the quota regimethat has been accelerated by the global economicdownturn has been the search for new markets.Under the quota restrictions, many companiesspecialised in producing for only one or a fewmarkets. The end of the regime opened newmarkets, at least among developed countries. Inaddition, many Hong Kong companies have shiftedtheir attention to the Chinese Mainland market.We note that it will be difficult for Hong Kongcompanies to compete in the Mainland marketagainst Mainland competitors in price sensitivesegments of the market. Instead, the Hong Kongfirms will probably have to compete in higherquality segments if they are to succeed in China.While some firms have focused on China as a newmarket, others have shifted some of their attentionto markets in Southeast Asia, South Asia, LatinAmerica, Eastern Europe, and even Africa.Another impact of the end of the quota regimeand increased cost and competitive pressure hasbeen on the range of products and services offeredby some garment companies. Under the quotaregime, companies often focused on one or twoproducts for which they had quota. The lifting ofrestrictions has allowed some companies to produceand sell a variety of garment products, since theproduction and support activities across products inthe garment industry are similar. A wider productrange, in turn, can help increase scale efficiency insome activities while allowing the firm to supply alarger portion of a buyer’s needs. A wider productrange and greater scale, in turn, has allowed somecompanies to invest more in design and has allowedthem to provide additional support services tocustomers that would not have been efficient for acompany supplying only a single product.As regulatory and policy pressure mounts forgarment production to relocate from the PRD,companies that are identified as developing newproducts, new designs, and their own brands maybe able to receive more favourable treatment thanother companies. While there are no guarantees,a company being able to show it is moving upthe value-added ladder may receive more flexibletreatment going forward.Finally, rising costs of operation in the PRD duringthe 2004 to 2007 had already driven some factoriesto close down or to relocate outside the PRD evenbefore the economic downturn of 2008-2009.More closed during the downturn. We expect thattough competition in the industry will lead to moreclosures and consolidations going forward.

71Case Study – Lever Style IncorporatedLever Style Inc. was founded in Hong Kong in 1956as Lever Shirt G.W.B & D. Factory Ltd. In 2007 LeverShirt merged with Trinity’s outerwear manufacturingdivision to form Lever Style Inc. (Lever Style).The company is led by a third generation familymember, Mr Stanley Szeto. In 1981 Lever Shirt wasone of the first garment manufacturers to openproduction facilities in China and the company nowhas a significant presence in Guangdong, whileretaining corporate headquarters in Hong Kong.Lever Style’s traditional line of business was OriginalEquipment Manufacturing (OEM) for establishedwestern brand companies but the company hassince extended into Original Design Manufacturing(ODM). The company’s focus is on high-endbranded products for clients such as ArmaniCollezioni, Armani Exchange, Banana Republic,Calvin Klein, Country Road, Hugo Boss, Paul Smith,Ralph Lauren, and Reiss. 136 They also produce midrangeproducts for the Japanese mass fashionretail company UNIQLO. 137Lever Style tends todeal with a relatively small number of customersthat have size and scale globally (Hugo Boss) orwithin a significant market (Country Road). The USis the largest market accounting for 40 per cent ofrevenue, the European Union, Japan, Australia, andother locations account for a further 40 per cent ofrevenue, with Mainland China making up the final20 per cent. 138The company currently has approximately 7,000 staffwith the majority of them based in Mainland China.Product design, customer service, merchandising,and sales are coordinated out of the Hong Kongand New York offices, while production is locatedin Guangdong. Lever Style manufactures more than10 million garments a year for men and womenacross a wide range of garment types and finishes.Issues and ChallengesPresently, cost pressure is the major issue for thecompany. Given its emphasis on designs andsales to high-end brands, Lever Style is a relativelyhigh-cost producer. The company manufacturesin Guangdong, which the company claims is thesecond highest cost location (to Italy) among majorgarment producing locations. Competition can alsobe tough in the sector. Barriers to entry are low inthe garment sector. In addition, there are suspicionsthat some competitors do not fully comply withlaws and regulations. This makes the competitivepressures more difficult.The most difficult aspect of operating in MainlandChina for Lever is having to explain to customersthat certain issues are hard to address due toregulatory uncertainty and bureaucratic obstacles,while its main regulatory concern is protectionism inthe West.Mr Szeto notes that “there are always new entrantswho try to do things cheaper.” The regulatoryissue that most troubles Mr Szeto, however, isprotectionism in the West. He comments that thequota system was protectionist in nature and thatwith its abolition, and with China’s accession tothe WTO, the world seems generally to be headingtowards freer trade.136 www.leverstyle.com.137 www.hktdc.com.138 www.hktdc.com.Lever Style is highly regarded by relevant players inthe garment industry for its creativity, innovation,and clever management.

72Company StrategyMr Szeto admits that he “doesn’t have a crystalball”. This means that the uncertainty brought onby the various business challenges confrontingLever Style must be dealt with proactively by havingstrategies in place to fit the business environment.Lever Style has responded to cost pressure byreengineering its processes to be leaner, moreflexible, and more efficient. Lever Style’s moveinto China in the early 1980s, long before manyother Hong Kong firms, meant that when brandedgarment retailers and brand owners from outsidemarkets came to Mainland China looking formanufacturers, Lever Style already had a trackrecordin China most Hong Kong garmentmanufacturers did not. More recently, Lever Stylehas tried to avoid fiercely competitive segmentssuch as low-value mass produced unbrandedgarments. According to Mr Szeto, “We don’tcompete based on price. We compete based on ourservicing, on our product development capability,on our reliability and on our reputation. We usethose things to differentiate ourselves from theguys who grab a hundred workers and start in thebusiness in the hope of making it. Those people arealways going to exist, but the customers that wework with may not have confidence on somebodylike that.”Central to Lever Style’s approach is differentiationthrough a combination of offering value-addedservices, providing superior service across allactivities that the company performs, beingresponsive to customer needs, and by maintainingan excellent company reputation. Mr Szeto cites therelationship with Country Road, a company thatused to simply tell Lever Style to buy a particularfabric from an Italian mill, buy other garmentcomponents from a Japanese supplier, and then“just stitch the garment for us.” These days, LeverStyle proposes both designs and fabrics to CountryRoad and sources the fabrics that Lever Style thinkswill suit their customer. Lever Style is involvedin ODM rather than just OEM and there is deepcooperation between the two companies.The company is selective in choosing customers,targeting high volume business and seeking to growas its customers grow. This often means turningaway potential business that is small in scale andpiecemeal. This is something that many firms arereluctant to do, particularly when they have sparecapacity, but as Mr Szeto notes, spare capacityis an asset that once given away is harder to fillwith other high-value adding orders. Low-value,patchy, and unpredictable orders are a distractionthat Lever Style attempts to avoid. Lever Style hasmade some strategic acquisitions and it now runs amulti-product operation that allows it to cross-sellits products. For example, the company used to sellonly shirts to Banana Republic, but it now also sellsthem suits. Mr Szeto notes that Lever Style’s “multiproductcapability” has helped it to generate moresales with its existing customers.Not all initiatives have succeeded. In the 1990sthe company set up a branded retail division andlicensed several low-end American brands. At thetime, it was thought that higher margins could bemade through retailing company-owned brands.Initially, the strategy worked and the companymade decent profits, but in the late 90s, the divisionstarted to suffer significant losses. It was clear thatretailing in Hong Kong and in China was goingto become even more competitive and that thecompany did not have the skills or the knowledgeto compete in that part of the industry. Lever Stylegot out of the business and is not looking to takeon a similar challenge in the foreseeable futureas it sees no natural synergy at an operating levelbetween manufacturing and branding and retail.Ensuring that the company has a diversifiedcustomer base was key in managing during therecent economic downturn. With this in place,Lever Style decided not to aggressively pursue newmarkets during the downturn but rather to focuson existing markets that were stable and to seekout developing them further for the time being.Lever Style is already well-known in its market. Thecompany does not participate in trade fairs. Thespace that the company occupies is relatively small

73and potential customers know of Lever Style and itscapabilities. Mr Szeto believes that as long as thecompany continues to act and think progressivelyand operate efficiently then new customers arelikely to be attracted over time and deeper workingrelationships with existing customers will also result.The fragmented nature of the garment industry andLever’s focused strategy means that the companydoes not actively monitor its competitors. Instead,it looks to learn from other companies. Mr Szetostates that Lever Style “tracks other companies notbecause they are competitors, but so we might seewhere they are doing well and learn from them.”Lever has adopted Toyota production methodswith its focus on designing out overburden,reducing inconsistency, eliminating waste, inventorymanagement, and Just-in-Time (JIT) delivery.Lever tries to remain environmentally and sociallyconscious. In addition to being careful to followall appropriate laws and rules, in 2006 Lever Stylebecame one of the first apparel manufacturers inChina to be certified for SA8000, one of world’sstrictest social responsibility standards. The companyhas also obtained ISO 9001:2000 certification, aswell as being certified by third party complianceaudit firms such as CSCC and ITS. In an environmentin which pollution and sustainability issues areincreasingly in the spotlight, having a reputation forenvironmental sustainability may lead companiesto do business with Lever Style. Mr Szeto notesthat “being sustainable doesn’t necessarily costmoney in order to save money. It is not like that youhave to spend millions of dollars to be sustainable,and being environmentally conscious gives areputational bump. We would rather be known asa company that is environmentally conscious thanas a polluter.” External recognition of Lever Style’scommitment to the environment came when thefirm’s factory in Shenzhen was chosen as one ofthree pilot factories in the Pearl River Delta that wasselected to run a WWF low carbon manufacturingprogramme.Over the years, Mr Szeto has restructured the familyowned business into more of a “modern competitivecompany.” This involved professionalising itsleadership and management teams, and byencouraging a flatter management style to permitmore direct and efficient communication, and moreautonomous decision making. Mr Szeto believesthat knowing his strengths and leaving it to othersto do the things that he is not particularly goodat has played an important role in Lever Style’ssuccess. Mr Szeto has strong strategic skills, butothers have excellent production skills and day-todaymanagement skills and he leaves these activitiesto them as much as possible. This frees up his timeto add value where his time is best spent.The company’s growth is evidence of its success indealing with competitive pressures. Five years agoLever Style was approximately half its current size.Mr Szeto benchmarks against the best, however,and notes that the company is not yet growing asquickly as Li and Fung which has doubled in sizeevery three years in the past two decades.Future PlansMr Szeto is bullish on opportunities in the industrysaying that “people will always need to buy clothes.There are sunset companies but this is not a sunsetindustry.” With this mindset, Lever Style plans totry and double in size every few years and achieveat least double-digit growth annually. If all goesto plan, Mr Szeto hopes that Lever Style will bebig enough to consider becoming a publicly listedcompany in a few years. Achieving this would putthe company in a stronger position to continueits growth by using its equity to make strategicacquisitions.

74In the long-run Lever Style plans to developproduction capability outside of MainlandChina, but it may do so by working with partnercompanies rather than “going it alone.” The ideawould be to continue doing the high value-addingwork in design, sourcing, and other services, and tosubcontract the labour intensive work to companiesin Bangladesh or Vietnam, for example. For now,there are plans to open a modern manufacturingfacility in Huizhou, Guangdong Province in late2010, with the prospect of producing 10 milliongarments annually and employing 8,000 workers, 139with a further overseas customer service office to beset up in London.Mr Szeto is keen for the company to be recognisedfor doing things a little differently, for doing thingsin a better and more creative way. He cites rolemodel companies as being Li and Fung in thegarment industry and Dell in terms of changing abusiness model in a “revolutionary way.”Lessons from the Lever Style CaseThere are a number of lessons that can be learnedfrom the Lever Style case.• It is important for firms to play to their strengthsand for owner-managers to do the same. Withprofessional management in the firm, owneroperatorscan do the tasks that play to theirstrengths and leave other tasks to others.• SMEs can successfully undergo generationalchange as long as succession issues are addressedat the right time.• To understand where the firm is comparativelyweak, the firm should benchmark against thebest firms in the industry and to look at what theoutside world is doing.• SMEs can benchmark aspects of their businessagainst leading firms from other industries andcan incorporate processes and systems that workin other industries where possible.139 www.hktdc.com.• Firms should accept that uncertainty will alwaysexist and they should not be constrained byit. Growth can and does occur in uncertainenvironments. What is important is that there arestrategies to deal with uncertainty by engaging inscenario planning and in forward thinking.• Companies need to continually adapt to theirenvironment and not keep unthinkingly doingthe things that worked for them in the past.Wishing that things would be different won’tchange the environment. Adapting is the onlyway to prosper long-term.• Costs should be reduced to the extent that thisis possible, but most SMEs will not have the scaleor the financial firepower to compete with largerfirms on a cost leadership basis. Thus they alsoneed to consider differentiation strategies.• SMEs can avoid fierce competition by choosingto do business in segments that have less directcompetition. Firms need to identify and focus onvalue drivers that will insulate them from purelyprice competition. For most Hong Kong SMEs,this will mean focusing on creativity, innovation,continuous improvement, flexibility, and reductionin lead- times. Being smaller and more nimble, SMEscan often carve out advantages in these areas.• SMEs in the sector should look to add value totheir customers by extending their operations toinclude ODM and OBM if they have the capabilityto do so. Firms that are able to offer theircustomers a wider range of services includingdesign, material sourcing, manufacturing,delivery, customer service, and after-sales serviceare likely to be more attractive.• Doing ODM is likely to be simpler than doingOBM. Building a brand takes a lot of time and isexpensive.• If the firm is able to integrate some of itsactivities or processes with its customers, thenthe customers are unlikely to give their businessto another firm. Such integration requires regularcommunication to understand the needs of thecustomer and to coordinate activities.• It is important to choose the right customers andto not just accept any order that is offered to thefirm. Companies should target customers that

75are likely to yield them profits and look to growalongside their customers.• Building a customer base that is diversified butthat places large and regular orders to createscale effects, and which will enable the possiblecross-selling of other products, will createsignificant upside while reducing risk.• Following the abolition of quotas, diversificationthrough the manufacture of multiple products isa more viable option for firms in the sector. Firmsthat pursue such a strategy will likely alreadypossess many of the capabilities they need tosucceed.• A reputation for reliability and having a goodreputation in general are vital to SMEs. Doingbusiness with firms with poor or uncertainreputations is just too risky a strategy for manyglobal customers, who are judged not just onprofits, but also on the labour and environmentalpractices of their suppliers. Further, the firm willneed to communicate its positive reputation inconvincing ways, because customers may nottake the time to do sufficient due diligencethemselves when they have other known low-riskoptions.• Firms in the garment sector should invest in staffrecruitment and retention policies as much of thevalue in the industry is added through having theright people (or destroyed by not having the rightpeople).• Success in the industry is dependent onidentifying and understanding trends in fashionand producing to cater to that demand more sothan it is on an ability to blindly mass produce.Managers who are in touch with the trends andwho have foresight regarding the industry are asignificant asset.• When in markets that require flexibility, firmsshould be careful not to overinvest in inflexibleautomation that is geared toward massproduction of goods that may not find a timelymarket.The Mould and Die IndustryMoulds and dies are used to turn metal, plastics,glass, rubber, and other source materials intostandardised components. Moulds and dies aretherefore important to a very wide range ofindustries including plastics, hardware, electricequipment, toys, home appliances, watches andclocks, auto parts, communication equipment,office instruments, optical instruments, consumerelectronics, and other products. 140The mouldand die sector is dominated mostly by firms fromdeveloped countries including Japan, Germany, theUS, and Italy. China is the only developing countrythat has a strong presence in the sector. Thedeveloped countries lead the sector in technology.Hong Kong’s mould and die industry started witha world-level production system borrowed fromthe US. 141Hong Kong firms have been gainingcompetitive strength since the 1980s whenthey started to move their production facilitiesto Guangdong. Today they have the capacityto produce world quality moulds and dies ata moderate price. The mould and die industryin Guangdong developed mainly as a result ofinvestment by Hong Kong firms. An estimate for2003 shows that there were over 10,000 HongKong invested firms in the PRD producing mouldsand dies employing about 81,000 Hong Kongstaff. 142Hong Kong firms currently lead theirMainland competitors in expertise and technology,but the gap has been closing. Chinese firms oftentarget experienced engineers and technicians fromforeign-invested firms to improve their knowledgeand competitiveness.140 Hong Kong Mould & Die Council and Hong Kong ProductivityCouncil, Survey Report on Technician Demand in the Mouldand Die Sector, 2005.141 Interview with Hong Kong Mould & Die Council, 9 April 2010.142 Hong Kong Mould & Die Council and Hong Kong ProductivityCouncil, Survey Report on Technician Demand in the Mouldand Die Sector, 2005.

76Industry players are confident that the ChineseMainland market will keep growing and they seestrong opportunities in the automobile, machinery,and electronic industries. 143 For instance, to produceone model of car requires 1,500 mould and diesets. 144With China selling 13.64 million motorvehicles in 2009 alone, 145 this is a large and growingmarket. This should provide ample opportunityfor Hong Kong companies that can find the rightniches going forward. However, Hong Kong’sposition in this industry is one that could comeunder significant competitive threat even as marketopportunities expand.143 Interview with Hong Kong Mould & Die Council, 9 April 2010.144 Advertising page, Hong Kong Mould & Die Council AnnualReport 2009.145 Report on the Work of the Government 2010, Wen Jiabao,delivered at the Third Session of the Eleventh NationalPeople’s Congress on 5 March 2010.146 Hong Kong Census and Statistics Department data on“Machinery, equipment, apparatus, parts and components,n.e.c”, 2009.147 Hong Kong Census and Statistics Department, Hong KongMerchandise Trade Statistics 2009, Domestic Exports and Reexports,Trade category UN SITC rev.3 code 7491 – Mouldingboxes for metal foundry; mould bases; moulding patterns;moulds for metal (other than ingot moulds), metal carbides,glass, mineral materials, rubber or plastics.Basic Facts about the IndustryThe Gross Industrial Output (GIO) for Hong Kongwas HK$5.4 billion in 2008 for the “Machinery,equipment, apparatus parts and components”sector which includes moulds and dies. There were5,591 employees in the sector in Hong Kong withan estimated average annual wage of HK$156,680.Wages were approximately 20 per cent of totalcosts for the sector. 146 Wages for the sector in HongKong are five times those for the sector in Chinaas a whole. This is likely explained by general wagedisparities between Hong Kong and China, theemployment of more senior staff in Hong Kong,and the fact that higher value end products areproduced in Hong Kong with corresponding higherquality and more costly labour inputs.Hong Kong’s total domestic exports for moulds anddies in 2009 were HK$188 million, a 13 per centdecrease from the previous year. Re-exports fromHong Kong were HK$2.9 billion or 0.12 per cent oftotal re-exports. No data is available for MainlandChina based processing and non-processing tradecompanies. 147 Japan was the world’s largest mouldand die exporter from 1991 to 2008, while Chinahas been among the top three since 2007. Thelargest importers of moulds and dies are the US,China, and Mexico.Exhibit 45. Average Monthly Wages for theSector in RMBRegionAverage Monthly WagesHong Kong 11,489YRD 1,881PRD 2,439China 2,200Source: Foshan, Dongguan, Shenzhen, Huizhou, Taizhou (JS), Nantong,Shaoxing, and Jiaxing City Statistical Yearbooks, 2009, China StatisticalYearbook, 2009.

77Exhibit 46. Top Mould and Die Exporters in the World and Hong Kong, US$ millions2007 2008 2009Exporter Value Exporter Value Exporter ValueJapan 1,821 Japan 1,969 Japan -Italy 1,389 China 1,850 China 1,769China 1,344 Germany 1,404 Germany 1,132Germany 1,253 Italy 1,274 Italy 1,094Korea 951 Korea 1,053 US 940Hong Kong 452 Hong Kong 467 Hong Kong 411Source: UN Commodity Trade Statistics Database 2007-2009, Trade category UN SITC rev.3 code 7491 – Moulding boxes for metal foundry; mould bases; mouldingpatterns; moulds for metal (other than ingot moulds), metal carbides, glass, mineral materials, rubber or plastics.Exhibit 47. Top Mould and Die Importers in the World and Hong Kong, US$ millions2007 2008 2009Importer Value Importer Value Importer ValueUS 1,593 US 1,533 Mainland China 1,210Mainland China 1,288 Mainland China 1,442 Mexico 1,143Mexico 1,061 Mexico 1,212 US 1,141Germany 694 Germany 841 Germany 735Japan 670 Japan 724 Japan -Hong Kong 406 Hong Kong 454 Hong Kong 414Sources: UN Commodity Trade Statistics Database 2009, Trade category UN SITC rev.3 code 7491.Exhibit 48. Mould and Die Exports from Hong Kong, HK$ millionsRegion2007 2008 2009Value Y-o-Y Change (%) Value Y-o-Y Change (%) Value Y-o-Y Change (%)World 3,523 1.3 3,635 3.0 3,187 -12.3Mainland China 1,486 -10.0 1,376 -7.4 1,294 -6.0US 420 -5.1 460 9.6 351 -23.8Vietnam 194 135.0 154 -20.8 219 42.6Germany 144 42.05 199 38.2 172 -13.8Notes: The major trade partners are based on the ranking in 2009.Source: UN Commodity Trade Statistics Database 2006-2009, Trade category UN SITC rev.3 code 7491.Exhibit 49. Mould and Die Imports to Hong Kong, HK$ millionsRegion2007 2008 2009Value Y-o-Y Change (%) Value Y-o-Y Change (%) Value Y-o-Y Change (%)World 3,164 -0.9 3,534 11.7 3,213 -9.1Mainland China 2,116 9.9 2,516 18.9 2,385 -5.2Japan 442 -27.8 488 10.4 384 -21.3US 64 -28.6 70 10.1 110 57.5Korea 190 84.5 158 -16.6 71 -55.5Source: UN Commodity Trade Statistics Database 2006-2009, Trade category UN SITC rev.3 code 7491.

78Exhibit 50. The Mould and Die Sector of Top Three Provinces (January-November 2008)Establishments Employment GIOValue Percentage (%) Value Percentage (%) Value (RMB billion) Percentage (%)China 1,932 100.0 348,065 100.0 90.87 100.0Guangdong 456 23.6 126,025 36.2 26.23 28.9Jiangsu 302 15.6 43,112 12.4 20.64 22.7Zhejiang 379 19.6 81,624 23.5 10.41 11.5Notes: Figures are of state-owned enterprises and non-state-owned enterprises with annual sales of RMB 5 million. Figures are preliminary.Sources: National Bureau of Statistics of China; China Mechanical Electrical Data Online.In recent years, China has grown into a majorproducer in the sector. In 2009, in the absence ofJapan’s statistics, China reported higher imports andexports for moulds and dies than any other country,with exports of US$1.7 billion and imports ofUS$1.2 billion. 148 The Pearl River Delta and YangtzeRiver Delta regions accounted for two thirds ofChina’s total mould and die output in 2007. 149 Thelargest producer, exporter, and importer of mouldand die products in China is Guangdong. In 2009,Guangdong exported US$756 million of mouldsand dies, 42 per cent of China’s total, and importedUS$368 million moulds and dies, 19 per cent ofChina’s total. 150148 UN Commodity Trade Statistics Database, category 7491(SITC.3). comtrade.un.org.149 www.cdmia.com.cn.150 Trade statistics the mould and die sector for individualprovinces of China may not all fall exactly into the UN SITCcategory of 7491 due to anomalies in the compiling ofChina’s statistics.151 “Current status and development trend for China Mould andDie industry”, Speech delivered by Cao Yan’an, Executive VicePresident of China’s Mould and Die Council, on InternationalMould Exhibition in Frankfurt, 2007. www.cdmia.com.cn.152 www.mymould.net.cn.153 News from the thirteenth China International MouldTechnology and Equipment Exhibition, 2010. www.mjcy.ibicn.com.154 Introduction of Hong Kong Mould & Die Council, www.industryhk.org.Domestic and export sales of mould and dieproducts for Mainland China grew at an annual rateof 20 per cent from 2000 to 2007, 151 but growthslowed in 2008 to 2009 as a result of the globalfinancial crisis. Sales in 2009 totalled RMB 100billion, 152 but sales in the first four months of 2010reached just under RMB 100 billion. 153 The domesticmarket is approximately seven times the size of theexport market.Issues for Hong Kong Mould and DieManufacturersHong Kong owned mould and die firms thatmanufacture in the Chinese Mainland haveadvantages in marketing, in implementinginternational business practices, and in maintaininggood customer relationships over the long termversus Mainland competitors. They also tend to bemore flexible, make decisions faster, be quicker toadopt new and suitable technologies, and respondto market changes rapidly. However, Hong Kongowned firms that manufacture in the Mainlandhave relatively high costs, are less aggressive thanMainland Chinese firms, and find it harder to obtainfinancing in the Mainland than their Chinese peers.Buyers in the mould and die industry are highly pricesensitive and competition from Mainland Chinaowned mould and die companies has intensified.The global financial crisis affected Hong Kongmould and die firms supplying traditional exportsectors like toys, home appliances, electronics,and computer peripherals. 154 With lower exportsin these markets, mould and die firms were put

79under pressure to reduce prices. During the worstperiod in 2009, demand fell by 40 to 45 per centfrom its peak. By 2010, prices were around 20 percent lower than the peak and profit margins forlarger companies down from 12 per cent to five percent. Firms that were small, could not offer specialtechnological advantages, or offer a niche product,were more vulnerable to the downturn and manyclosed down.Growth in the sector is becoming more difficultfor Hong Kong SMEs because they are less likelyto receive the sort of capital allocations that arebeing given to Mainland China companies. Oftenlarge investments of up to RMB 100 million aremade into Mainland China companies. Several ofthe large Chinese mould and die companies haveacquired advanced equipment and technologiesfrom Germany, Japan, and the US, that has giventhem the capability to develop high quality moulds.These companies are encroaching on the marketshare held by Hong Kong owned mould and diecompanies.Since the mould and die industry is less labourintensivethan many other industries in the Pearl RiverDelta, it is less vulnerable to labour cost increasesand costs associated with administering the LabourContract Law than in many other industries. 155However, the industry uses specialised labour in theform of highly trained technicians and this categoryof labour is often in short supply. Hong Kongfirms find that their Mainland Chinese personnelsometimes leave to start their own companies oncethey have received sufficient training. This createsadditional competitive pressure. 156Local protectionism in Mainland China is animportant issue affecting Hong Kong mould anddie companies. The mould and die industry is thebasis of the machinery sector, providing essentialproducts to its downstream industries. In orderto develop their own industries, many Chineseprovinces treat the mould and die industry as astrategic industry and offer favourable policies tosupport and develop indigenous companies. YRDgovernments have been particularly aggressivein their attempts to compete with the PRD andthis is having a significant impact on Hong Kongowned companies. The Guangdong Governmentalso offers favourable policies to local mould anddie companies, but applies stricter criteria whenassessing the eligibility of firms that are not fullyowned by Mainland interests, so companies fromHong Kong lose out both ways.The Central Government has implemented atwo-year plan (2009-2011) for restructuring andrevitalising 10 key industries. This may result in anincrease in demand for mould and die products,which would improve the long-term potentialof the sector. The Guangdong Government hastabled its own restructuring and revitalisation plansfor 11 key industries. The plan for the equipmentmanufacturing industry 157 will have the greatestdirect impact on the mould and die sector and isdesigned to encourage its development so as tosupport other industries that have been identified asvalue-adding.It is further expected that the time extension ofthe “Home appliance and motor vehicles to thecountryside” and the “Motor vehicle and homeappliance replacement” policies will boost the salesgrowth of motor vehicles and home appliances in2010. 158 In 2009 alone, the Central Governmentprovided RMB 45 billion in subsidies for vehicleand appliance trade-ins and for rural residents topurchase home appliances and motor vehicles,including motorbikes. 159155 China Statistical Yearbook 2009, calculated ratio of GIO toEmployment.156 Interview with Hong Kong Mould & Die Council, 9 April 2010.157 “Opinion on Implementing the Plan for Restructuringand Invigorating Guangdong’s Equipment ManufacturingIndustry,” Yuefuban [2009] no 121, 10 November 2009.158 The “Vehicles to the Countryside” policy has been extendeduntil 31 December 2010 and the “Motorcycles to theCountryside” policy until 31 January 2013. The current “Homeappliance replacement” policy has been extended until 31December 2011.159 Report on the Work of the Government 2010, Wen Jiabao,delivered at the Third Session of the Eleventh NationalPeople’s Congress on 5 March 2010.

80The mould and die sector is not limited by anyexport processing restrictions, it is also not likelythat suppliers to the sector are limited because therestricted categories cover processed metals and notthe raw unprocessed metals that are used in mouldand die production. In July 2010, export rebateson 406 products including key steel products, andsemi-finished nonferrous metals were eliminated.Steel is a key input for mould and die sector. In June2010, the State Council announced a restructuringof the industry by closing smaller less efficientplants, consolidating towards larger plants, andupgrading the production and energy efficiencyof the plants. These moves may have a short-termimpact on supply for the mould and die sector.Policy support for the industry as well as increasedoverall need for mould and die operations hasled some large customer companies to set uptheir own mould and die shops. The nature of theindustry is that many customers are large, havesufficient internal demand, are financially secure,and can obtain the capital needed to take mouldand die manufacturing in-house. Consequently, anumber of firms in the sector have seen orders fromlongstanding customers go to nil in a relatively shortperiod of time.Response Strategies of Hong Kong SMEsLarger companies that survived the global financialcrisis scaled back new product launches and focusedmore on maintaining and improving the quality oftheir existing product range. 160One response to lower operating margins has beento improve efficiency through the use of innovativetechnology or automation that will bring aboutlong-term efficiencies and cost reductions160 Interview with Hong Kong Mould and Die Council, 9 April2010.Another approach has been to identify attributesthat customers value enough to justify a pricepremium such as new product features, creativedesigns, or faster response times. In this way, theHong Kong firms are playing to their advantagesof modern equipment, advanced technology, gooddesign, tightly controlled production, and strictquality control.Some Hong Kong firms are differentiating on thebasis of technology, which requires significantinvestment that might be challenging for HongKong’s SMEs given their small size. However, itappears that in this sector companies which focuson research and development, technology adoption,and innovation to the extent that they are able mayface the best prospects of doing well in the future.Some firms are investing a proportion of theirrevenues into ongoing research and development,while others have formed joint-venture partnershipsor entered into other business arrangements withtechnology providers that keep them at the front ofadvances in manufacturing technology.To combat the problem of obtaining sufficientcapital, Hong Kong SMEs in the sector havemade efforts to communicate their advantages toinvestors from the region or from overseas. Forglobal investors, these advantages go beyond thosealready mentioned to include an ability to bettercommunicate in English, as well as better socialand physical infrastructure that attract potentialforeign-firm investors during their visits to the PRDvia Hong Kong. Firms in the sector have also takento partnering with firms in the Chinese Mainland totap into the funds that those firms can access.Hong Kong firms have been limiting the number ofemployees they have outside low-cost environmentsto try to maintain cost parity with Mainland firms.Moving to the YRD is also a strategy that HongKong firms in the sector are considering in order toobtain workers they need and to compete againstother lower cost manufacturers who operate in theYRD.

81Some Hong Kong firms are finding ways to partnerwith customers to ensure their customers donot establish in-house mould and die activities.There are several ways in which this type of deepcollaboration could take place with the mainpoints for agreement being which firm takes onthe capital risk by investing in the equipment,and what guarantees are put in place to ensurethat outsourcing remains more beneficial to thecustomer than bringing the mould and die activitiesunder its own control. Deeper collaboration thatdoes not involve in-house manufacturing is alsobeing achieved by locating next to the factories ofmajor customers.Hong Kong firms are responding to protectionismin China by lobbying, but this is being donewith an understanding that little is likely to beachieved. Some Hong Kong mould and diemanufacturers hope to overcome possible policybias by demonstrating that due to their experience,managerial capabilities, and capacity to innovate,they have more value to add to the industry thanindigenous firms, and to underscore the belief thatthey are important to the downstream activitiesthat remain attractive to provincial governments inChina.Case Study – Datamatic CNC EngineeringCompany LimitedEstablished in 1983, Datamatic CNC EngineeringCompany Limited (Datamatic) is a mould and diemanufacturing company headquartered in HongKong. After a few of years of sub-contracting CNCjobs, Datamatic acquired the International MouldFactory Company Limited in 1985 to providecomplete sets of injection moulds. Datamaticcommenced business with five employees and thecompany now has approximately 190 employees withall except six being located in the Chinese Mainland.In 1995, Datamatic shifted its production from HongKong to the PRD where it set up a Sino-Hong Kongjoint venture named Datamatic Guangzhou InjectionMould Company Limited (Datamatic Guangzhou).The joint venture built a workshop of 3,000 squaremetres in Guangzhou to provide turnkey mouldmaking and pilot moulding solutions. In 2005,Datamatic Guangzhou expanded its workshop andinstalled an advanced moulding machine. At first,Datamatic relocated all of its manufacturing butkept its engineering activities in Hong Kong. Afterabout two to three years, Datamatic moved itsengineering activities to Guangzhou as well. Thesedays, Hong Kong acts as a liaison office and takescare of the coordination and planning of activitiessuch as marketing and shipping.When Datamatic first moved to China business wasslow. To try and develop new business, Datamaticengaged in marketing and promotion activities inmajor potential customer markets. This involveddoing exhibitions, sending company catalogues out,ensuring that the website was up-to-date, and arange of similar activities. At one of the exhibitionsa German company making automotive lighting(Hella) placed a trial order with Datamatic. The firmtook the trial order very seriously, the order wentvery well, and Datamatic got a foothold in theautomotive lighting industry, an industry that hasbecome its main market.Datamatic sells its products all over the world withmajor markets in China, the US, France, Germany,Spain, Mexico, and Brazil. Its major direct clientsare car component manufacturers such as Hella,Valeo, AL, Decoma, CML, ARTEB, Stanley, andKoito. Approximately 50 per cent of Datamatic’sproduction stays in the Chinese Mainland and theother 50 per cent is shipped to other places.

82Issues and ChallengesDealing with cost-driven competition from MainlandChina owned mould and die companies is one ofDatamatic’s major challenges. Steadily decreasingprices for mould and die manufacturing is a furtherchallenge for Datamatic. Although the turnover inthe mould and die industry in Mainland China isincreasing, average product prices are dropping.The industry is relatively capital intensive and thetechnology used in the industry is fast evolving,meaning that regular investments in technologymust be made. Smaller firms like Datamatic facerelatively large costs if they try to pioneer newtechnology.There is a shortage of skilled technicians for thesector in the PRD. The entry and growth of firmsfrom the Chinese Mainland has increased demandfor trained engineers and technicians. ManyDatamatic employees have been offered attractivepackages by Chinese firms and a number have leftto start companies of their own.China’s regulatory environment is viewed asmore onerous than Hong Kong’s. Performingroutine tasks in China takes far longer thanit takes in more developed and less heavilyregulated markets. However, the actions takenby the Chinese Government occasionally work inDatamatic’s favour. For instance, when Datamaticmoved to Guangzhou in the 1990s the companywas given a tax holiday on company tax for threeyears at half-tax and for two years entirely free oftax.Early on, Datamatic met with a significant challengewhen its partner in the Mainland did not buy nearlyas much from Datamatic as was initially projected.Datamatic had already invested in additional staffand facilities with the expectation that significantinternal demand from within the group ofcompanies controlled by the Mainland Chinesepartner would be forthcoming. When this didnot occur, Datamatic had to reassess its businessaspirations and accept several loss-making years.Company StrategyDatamatic’s key response to its various challengeshas been to focus on developing a niche marketin automobile lens moulds. This niche feeds intothe automobile market in the Chinese Mainland, amarket that is projected to grow rapidly. Presentlythe niche strategy is paying off and approximately95 per cent Datamatic’s sales are related toautomotive lighting. Being a smaller and morenimble operator allows Datamatic to be moreflexible, to make decisions faster, to more quicklyadopt new and suitable technologies, and to rapidlyrespond to market changes. This enables Datamaticto create advantages that are hard for the largeMainland owned mould and die manufacturers tomatch.Datamatic’s focus is to continuously improve itsoperations and its business step-by-step. Being asmaller operator the company does not have themoney to spend to make quantum leaps in thedevelopment of technology, but it makes targetedinvestments in research and development to keepthe company at the leading edge of technologyand to improve the precision and efficiency ofits operations. It also applies new affordabletechnology developed by others. For example,Datamatic was the first company in Hong Kongthat provided Computer Number Control (CNC),Electrical Discharge Machining (EDM), Wire-EDM,and CNC services. Datamatic was one of the firstto start to fully computerise its equipment in 1988.Datamatic regularly teams up with professionalorganisations such as the Hong Kong ProductivityCouncil) and strategic partners to explore morebusiness and technology advancement. Datamaticalso takes part in activities that are organised by theHong Kong Mould & Die Council to get the latestindustry information which it then uses to makecontinuous improvements to its business.

83Datamatic has worked hard to develop a goodreputation and a good client network. Throughthese assets, Datamatic has advantages overMainland China owned competitors in obtainingbusiness, in implementing international businesspractices, and in maintaining good customerrelationships over the long-term.Datamatic moved into China to follow major clientswho began setting up significant manufacturingoperations in the PRD. The company identified apossible partner in Guangzhou and formed a jointventure in 1995. This helped reduce land and labourcosts and improved access to labour. Datamatichas found that workers from Guangzhou are lesslikely leave the company and set up as competitorsthan workers who come from other parts of China.Knowing them to be more stable, Datamatic targetsworkers from Guangzhou. Increasingly however,Datamatic is finding that it is difficult to attractworkers from Guangzhou. In recent times, thismeans that Datamatic has had to look to recruitstaff from the Northern part of China.The company knows that its staff make thedecisions and take the actions that will help itremain competitive. This means that the staffhave to be well trained so that they are capable ofmaking decisions and taking action as required. Tothis end, Datamatic has in collaboration with severaluniversities implemented a number of training andeducational programmes aimed at developing itsstaff.Quality accreditation is important to Datamaticas a signal to its customers that the company iscommitted to quality, and as a means of drivinginternal improvements. Datamatic has ISO9001:2000 accreditation and has adopted elementsof ISO 16949 in its manufacturing system. Thecompany has also instituted a Quality ImprovementCommittee to help review and improve productstandards. Datamatic has received an “OperationExcellence Award” as well as awards for “moulddesign” several times from the Hong Kong Mould &Die Council.Datamatic does no direct marketing these days,because it operates in a niche market in which allthe key players in the industry know one another.The number of major clients is “less than ten”and the number of firms that Datamatic counts asserious competitors globally in its niche is between10 and 15 companies. Datamatic has a smallercapital base than all the companies it considerscompetitors. If competition was based purely onfinancial strength rather than on other factors likequality, innovation, and reliability, then Datamaticwould have to fight hard to survive.The General Manager of Datamatic, Mr Leton Lee,thinks that the most important element of successis being aware of changes in market, changes intechnology, changes in business environment,fundamental changes to the industry, and change ingeneral. Companies have to learn how to managechange and how to respond quickly to shifts inthe factors that affect the business. Datamatic hasadapted to the need to deal with change by findingan “optimum size” and sticking to it. Datamatic’sbusiness is set up to afford maximum flexibility. Theproduction line, in particular, is designed to be ascompact as possible to enable Datamatic to be moreflexible and responsive to client needs.Future PlansDatamatic plans to maintain stable and steadygrowth into the future and does not intend doinganything “too aggressive.” This translates intoexpectations of revenue growth of around five percent each year for the coming five years, greaterthan five per cent increases in profit, and doubledigit salary increases for staff.

84The company will invest in research anddevelopment, concentrating particularly on thedevelopment of new manufacturing methodologyand on improved machine facilities. Datamaticplans to install more new facilities and more highendmilling machines. The investment patternduring the last few years has been to reinvest a percentage of company sales revenue into researchand development and the establishment of newfacilities. This practice will continue into the futuresince the old machines depreciate fast and thetechnology changes fast.Datamatic is considering setting up a subsidiaryin the YRD to support its clients in that part ofChina. The company does not envision movingmanufacturing wholesale to the YRD, but it cansee the merit in considering expanding into theYRD so as to have a presence there alongsidemajor clients. Datamatic does not plan tomanufacture outside of China. The company isoptimistic about the Chinese automobile marketand about the opportunities for growth in itsniche. Datamatic enlarged the size of its plantin 2005 and purchased more equipment. Thesechanges allow for further product diversificationwhich will make Datamatic more competitive. TheCompany plans stay at the forefront of advancesin technology and it will continue to focus onmanufacturing high-end products for automobilelighting components.Datamatic aims to be a sustainable manufacturerand to maintain a harmonious relationship with thecommunities in which it operates. The companyis committed to environmental protection so as toprovide for a better future for all people and to thisend it has invested in a waste recycling system toreduce pollution and to be able to claim status asan environmentally friendly firm.Lessons from the Datamatic CaseThere are a number of lessons that can be learnedfrom the Datamatic case.• Firms in the sector need to learn to expect andanticipate changes in market, technology, andbusiness environment, and be ready to adaptquickly in the ways that are needed to survive.• Hong Kong firms must demonstrate their valueto customers that are considering taking theirmould and die work in-house by emphasising theadvantages that accompany sourcing externally,the expertise that a specialist company canprovide, a willingness to better understand andanticipate customer needs, and opportunities toengage in forms of business collaboration.• Firms should diversify customer risk by developingrelationships with more multiple customers inmultiple geographic markets and in multipleindustries.• Hong Kong firms operating in the PRD facehigher materials costs than many of theirMainland competitors as well as potentialmaterial shortages because non-local companiesare required to import some of the criticalmaterials that are used in production.• Since SMEs in the mould and die industry usespecialised labour that can be attracted away bycompetitors or can leave to set up firms of theirown, the SMEs need to have means of attractingand retaining key personnel.• Firms can combat labour shortages by payinghigher wages and offering better conditions andbenefits to workers than competing firms.• SMEs may consider moving their manufacturingoperations to other locations, such as the YRD,where competition for skilled workers is lessintense at present and where costs are lower ingeneral.• SMEs should identify and take advantage ofincentives and policy measures that are put inplace by authorities in Mainland China. Thesewill be different across different locations andwill have time-limits. SMEs will need to do theirhomework to figure out which incentives bestsuit them.

85• Companies that try to compete based purely onfinancial strength rather than on other factorslike quality, innovation, flexibility, and reliability,will have to fight hard to survive• SMEs should focus on developing a niche market.Being a niche operator allows an SME to be moreflexible, to make decisions faster, to more quicklyadopt new and suitable technologies, and torapidly respond to market changes. This createsadvantages that are hard for the large Mainlandmould and die manufacturers to competeagainst,• The mould and die industry is capital intensiveand the technology is fast evolving. To remaincompetitive, firms should consider how theywill fund ongoing investments in research anddevelopment and facilities.• Increased environmental and pollution concernsmean that a firm that can claim status as beingenvironmentally friendly is likely to improve itschances of securing business and developing newbusiness relationships.• SMEs won’t have the money to spend tomake quantum leaps in the development oftechnology, but they can be alert to advancesin technology and apply new technology whenothers develop it.• Quality accreditation is an important signalto customers that the company is committedto quality and is a means of driving internalimprovements.The Toy IndustryHong Kong companies play an extremely importantrole in the world toy industry. Together, Hong Kongand the Chinese Mainland account for around 75per cent of global toy manufacturing. Over 70 percent of the toy manufacturers in China are basedin Guangdong Province, mostly in Dongguan,and many of them are Hong Kong companies. 161Hong Kong’s toy industry produces a wide varietyof products. Hong Kong toy manufacturers havedeveloped deep market, customer, logistics, andproduction knowledge and have broad networks.Although increasingly challenged by indigenousChinese enterprises, Hong Kong toy manufacturersdistinguish themselves from competitors throughtheir quick responses, efficiency, reliability, andthrough their compliance with common standards,regulations, intellectual property rights, and codesof practices; the latter features all being critical tosecuring OEM orders from overseas industry giantswho require ethical sourcing practices.Most Hong Kong toy manufacturers engage in OEMproduction, mainly in the form of export processingin Guangdong Province. There is, however, agrowing trend for Hong Kong toy manufacturersto pursue higher value-added activities like productdesign, prototype manufacturing, and branding.Several famous brands have been developed byHong Kong toy manufacturers including Playmates,May Cheong, Silverlit, Toy2R, and Hot Toys.161 www.glokids.cn.

86Industry participants do not expect intensecompetition from outside of the Chinese Mainlandor Hong Kong in the foreseeable future. Theyreason that India has too much red tape, notenough infrastructure, and a different mindsetthan the one that is needed to succeed in the toyindustry; Vietnam is a late entrant that has not yetaccumulated the technical skills to make a widerange of toys; Taiwan and Korea have alreadymoved to higher tech/higher value industries;Thailand and the Philippines lack political andeconomic stability or supply networks; andIndonesia, Bangladesh, and Sri Lanka would haveto start almost from scratch to build a presencein the toy sector. Other locations that wereonce competitors have been beaten by lowerproduction costs in the Chinese Mainland andby logistics systems, often based in Hong Kong,that link production in China to global markets.Thus the expectation is that Hong Kong and HongKong companies will continue to have a strongcompetitive position, though margins may comeincreasingly under threat.Basic Facts about the IndustryThe Gross Industrial Output (GIO) for Hong Kongwas HK$151 million in 2008 for the “electricalappliances and houseware and electronic toys”sector which is the only industry line within the toysindustry for which recent data is publicly available.Hong Kong employment for electrical appliancesand houseware and electronic toys is low with 414persons employed at an estimated average annualwage of HK$99,729. Wages were approximately32 per cent of total costs. 162 Wages for electricalappliances and houseware and electronic toys inHong Kong are five times those for the sector in162 Hong Kong Census and Statistics Department data on“Electrical appliances and houseware and electronic toys,”2009.163 Hong Kong Census and Statistics Department.China as a whole. This is likely explained by generalwage disparities between Hong Kong and Chinaand the employment of more senior staff in HongKong.Exhibit 51. Average Monthly Wages for theSector in RMBRegionAverage Monthly WagesHong Kong 7,328YRD 1,567PRD 1,543China 1,585Sources: Foshan, Dongguan, Shenzhen, Huizhou, Taizhou (JS), Nantong,Shaoxing, and Jiaxing City Statistical Yearbooks, 2009, China StatisticalYearbook, 2009.Total exports of toys, baby carriages, games, andsporting goods from Hong Kong in 2009 wereHK$104.9 billion, or 4.2 per cent of Hong Kong’stotal exports. The US and the EU were the twobiggest markets for Hong Kong’s toy exports,accounting for 56 per cent of the total. Demand fellin both these markets with the economic downturnthat began in late 2008. Hong Kong’s exports intothe US fell by 28 per cent in 2009, and those to theEuropean Union fell 10 per cent (Exhibit 52). Reexportsof toys, baby carriages, games, and sportinggoods from Hong Kong were HK$104.7 billionor 4.3 per cent of total re-exports (Exhibit 53).Export processing facilities in the Chinese Mainlandaccounted for HK$50.1 billion of this total (Exhibit54), while Chinese Mainland-based non-processingtrade companies accounted for a further HK$29.4billion 163 , the balance of the re-exports being fortoys from places other than Mainland China. Totaldomestic exports for this sector in 2009 wereHK$137 million, a 21 per cent decrease from theprevious year.In 2009, imports of toys, baby carriages, games,and sporting goods to Hong Kong were HK$91.9billion, or 3.4 per cent of total imports. The ChineseMainland accounted for 83 per cent of the imports,followed by Japan, the United States, and Taiwan(Exhibit 55).

87Exhibit 52. Exports of Toys, Baby Carriages, Games, and Sporting Goods from Hong Kong,HK$ millionsDestination2007 2008 2009Value Y-o-Y Change Value Y-o-Y Change Value Y-o-Y ChangeWorld 109,924 20.8% 120,078 9.2% 104,914 -12.6%US 33,545 4.1% 34,402 2.6% 24,783 -28.0%EU 30,094 20.9% 37,402 24.3% 33,561 -10.3%Japan 9,257 -8.9% 8,254 -10.8% 9,063 9.8%Note: Trade category UN SITC rev.4 code 894 - baby carriages, toys, games, and sporting goods.Source: Hong Kong Census and Statistics Department.Exhibit 53. Toys, Baby Carriages, Games, and Sporting Goods Re-exported from Hong Kong,HK$ millions2007 2008 2009Total Value Y-o-Y Growth Value Y-o-Y Growth Value Y-o-Y GrowthWorld 109,711 20.9% 119,875 9.3% 104,756 -12.6%Source: Hong Kong Census and Statistics Department.Exhibit 54. Chinese Mainland Process Industry Toys, Baby Carriages, Games, and Sporting GoodsRe-exported from Hong Kong, HK$ millionsToys, Baby Carriages, Games, and Sporting Goods Re-export of Processing ProductsManufactured in the Chinese Mainland2006 2007 2008 2009Value 62,046 70,682 66,595 50,184Source: Hong Kong Census and Statistics Department.Exhibit 55. Imports of Toys, Baby Carriages, Games, and Sporting Goods to Hong Kong, HK$ millionsOrigin2007 2008 2009Value Y-o-Y Change Value Y-o-Y Change Value Y-o-Y ChangeWorld 95,651 21.2% 109,477 14.5% 91,980 -16.0%Chinese Mainland 74,940 27.7% 91,150 21.6% 76,334 -16.3%Japan 14,568 -6.4% 11,817 -18.9% 9,754 -17.5%US 1,822 49.8% 2,043 12.1% 1,675 -18.0%Taiwan 931 -7.8% 746 -19.9% 586 -21.4%Source: Hong Kong Census and Statistics Department.

88Issues for Hong Kong Toy ManufacturersSimilar to other Hong Kong manufacturers in thePRD, Hong Kong toy companies also face challengesfrom changes in markets, powerful buyers andlicense holders, increasing competition, andincreased costs associated with rising wage ratesand input costs, the appreciation of the RMB, theimplementation of the Labour Contract Law, andshifts in policies on export processing. In addition,as a relatively labour-intensive and low value-addedindustry, the toy sector is feeling the effects of theindustrial upgrading movement that is being pushedby both the Central and Guangdong ProvincialGovernments. As an industry heavily reliant onboth plastics and packaging, it also attracts itsshare of attention from Mainland and overseasenvironmentalists concerned about production oflarge amounts of yet more potential waste, despiteindustry efforts to use recycled plastic materials.The toy sector was under pressure before theonset of the global economic downturn in 2008.Wage increases in the toy sector had been risingat double digit per centages each year. In addition,it is estimated that the implementation of LabourContract Law alone added 30 per cent to the labourcosts for toy manufacturers in the PRD. 164 The priceof raw materials used in toy manufacturing, such asplastic and metal fittings, had also increased. 165 Thetoy sector was also negatively impacted by changesmade by Mainland Government authorities in June2007 that lowered the export VAT rebate for toys164 www.fisme.hk165 Wei Jin, “Winter of Toy Industry in China”, Consumer Guide –Academic version, April 2010.166 Note that the Hong Kong Toys Council estimates that in 2007there were 8,500 toy factories and exporters in Guangdongand that this had decreased to about 3,000 toy factories andexporters by 2010.167 Wei Jin, “Winter of Toy Industry in China,” Consumer Guide –Academic version, April 2010.168 www.easttoys.com.169 www.glokids.cn.170 www.past5000.com.171 See Hong Kong Trade Development Council, “Hong Kong’sExport Outlook for 2010: Challenges amid a Slow GlobalRecovery,” 16 December 2009.from 13 per cent to 11 per cent. In 2007, 1,454of the 1,725 toy factories inspected in Guangdongwere found to have safety flaws. A total of 764 ofthese factories lost their export licences or had themsuspended. In August 2007, the Certification andAccreditation Administration of China issued newregulations for toy exporters that makes it moredifficult to obtain and retain an export licence.According to Guangdong Customs, from Januaryto July in 2008 there were 1,404 toy companiesin Guangdong doing export business, which was3,618 fewer than one year earlier 166 . This meansthat 72 per cent of the toy companies either exitedthe export market altogether or put their exportingactivities on hold. 167In the first quarter of 2009, the EU announced 143 toyrecalls, 134 of which concerned toys that originatedfrom the Chinese Mainland. During the same period,the US and Canada announced 13 toy recalls, all ofwhich were for Chinese products. This led to anotherround of new safety and environmental laws inthe US and EU. The combination of new Chineseand overseas regulations have increased input,compliance, quality management, and licence costs.Demand for toys from the US and the EU decreaseddramatically with the onset of the global economicdownturn. In 2009 and Hong Kong’s exports to thesetwo markets were down 19 per cent from 2008. Inresponse, the Chinese Government raised the exporttax rebate for toy exports from 11 per cent to 14 percent in November 2008, and further raised the exporttax rebate to 15 per cent in June 2009, in an attemptto stimulate toy exports. In the first ten months of2009, toy exports in China decreased 11.2 per cent,and toy exports in Guangdong Province decreased10.9 per cent. 168 Industrial players estimated that HongKong’s toy exports would grow between zero and 10per cent in 2010. 169 In the first four months of 2010,Guangdong’s toy exports increased 21.4 per cent yearon-year.However, Guangdong Customs indicatedthat most of the orders were short-term orders, andthe outlook of the industry was still uncertain. 170 Asurvey published by HKTDC in December 2009 171indicated that the demand for basic toys will continue

89into the medium-term. A further survey released bythe HKTDC in January 2010 found that just 34 percent of Hong Kong manufacturing sector respondentswere optimistic as to the business outlook for thetoy industry in 2010, and another 48 per cent ofrespondents were neutral in their outlook. 172Despite the increased costs, toy manufacturers,particularly SMEs, have not been able to raise pricessufficiently to offset the cost increases because ofwidespread consumer resistance to paying more formost toys and because they lack negotiating powerwith trade buyers. Consolidation of toy retailingin major markets at the retail level has given morepower to fewer toy brands and retailers, leavingthe “big four” retailers including Wal-Mart andToys “R” Us, and brand holders like Hasbro andMattel in a position to exert their buying powerso as to compress manufacturer profit margins.The profit margin of toy companies in Shenzhenhas been reported to be three per cent to fiveper cent on average, and even lower for SMEs. 173Financial pressure has led to the closure of manytoy factories, especially as sub-sub-contractinghas become higher risk in terms of compliancemanagement.Competition is also becoming fiercer as thetoy market in Mainland China expands and toyproduction spreads across China. Two major factors– cheaper prices and copycatting in the Shantouarea – are hurting smaller Hong Kong-owned PRDfactories. Many toy factories in Mainland Chinaare targeting the domestic and developing worldmarkets where controls over intellectual propertyviolations and safety are less rigorous. This is hittingmid-size own-brand Hong Kong toy manufacturersthat target the same markets.Kong toy manufacturers to go beyond Guangdongas the further from the Greater PRD they go,the less of a competitive edge they have relativeto the Mainland toy manufacturers. It may notbe practicable, for example, to replicate outsideGuangdong the current model of employingmigrant workers recruited from cheaper labourmarkets elsewhere in the Mainland and housed inlarge factory compounds. Moreover, most toys arenot high value items and the scope to increase theirvalue is limited. Similarly, the scope to overhaul orupgrade long-established production technology islimited.Response Strategies of Hong Kong SMEsHong Kong toy manufacturers have engaged ina range of strategies to deal with recent issues.In general, Hong Kong toy manufacturers areattempting to maintain a presence in traditionalOEM manufacturing while at the same time tryingto find ways to add value to existing products andprocesses, carve out profitable niches in existingproduct categories, develop new products in nichemarkets, develop branded products, build businessin the Chinese Mainland, and partner with firms inthe entertainment industry to create toys that arepopularised via a presence in films, television, theinternet, and theme parks.172 Hong Kong Trade Development Council, “On the Roadto Recovery: Assessment of 2009 Christmas Sales in MajorMarkets,” 29 January 2010.173 www.glokids.cn.Toys were one of the first Hong Kong industries toenter the PRD, which makes the “empty the cage”policy of the Guangdong Government that seeksto push out companies in traditional industriesin favour of companies in “higher technology”industries particularly hard for them to accept.Presently, there are few viable options for Hong

90We note the following:• Hong Kong toy makers are looking to enter theChinese market in order to tap into demandassociated with the estimated 252 millionchildren aged fourteen and under. Many HongKong firms have entered in a small way to learnmore about consumer requirements in Chinaand how they differ from those in traditionalmarkets. However, selling into China is not easy.According to interviewees, obstacles to HongKong toy manufacturers entering the Chinamarket include an immature market structure,poorly established or inaccessible distributionchannels, unclear regulations, under-the-tablepractices, and difficulty collecting on invoices. 174• Most toy manufacturing is relatively labourintensive and apart from moulding and injectionwork, many of the manufacturing activitiesare hard to automate. This means that labourcosts need to be kept low in order to remaincompetitive. It also means that firms need tohave access to a steady stream of workers. Toachieve this, some firms have already moved outof traditional manufacturing areas in the PRDto locations such as Shaoguan, and to othermountainous areas of Guangdong from whichsemi-rural labour can be more easily sourcedat cheaper rates. However, the new locationsare further from Hong Kong and ports, makinglogistics less convenient and more costly. Logisticscosts and proximity considerations need to becarefully weighed against cost of labour andaccess to workers.174 ESA interviews with industrial players.• Contract manufacturing of toys is considered acommodity business and companies that only doOEM are likely to have limited life, limited profits,or limited growth unless they have additionalor superior services to offer to their customers.Such companies face fierce price competitionunless they find ways to add value by superiorperformance or through bundled services.• Developing branded toys is a strategy to addvalue that is being followed by an increasingnumber of Hong Kong firms. Some are selfbrandingin the Hong Kong and Mainlandmarkets while co-branding with leading firmsin other markets such as the US. Co-brandingallows the Hong Kong firm to gain quickaccess to large markets alongside known andrespected brands, knowledge that may help thefirm build its own brands in other markets, andthe opportunity to perform other activities andservices (such as OEM manufacturing) for its cobrandingpartners.• Improving product design and applying upgradedtechnology are other ways for Hong Kong firmsto add value. In the PRD, the technology inthe toy industry is already quite advanced, butHong Kong firms have dealt more extensivelyand over a longer period of time than mostcompetitors with international firms that requiremanufacturing to be done to global standardsand in compliance with stringent requirements.Some Hong Kong firms have engaged intechnology reengineering projects to maintaintheir competitive edge, others have focused oncombining engineering excellence and designcapabilities to build new features into toys.• Some firms are extending their scope by usingengineering skills developed in the toy sectorto enter crossover markets such as electroniclearning products or the smart phone sector.

91• As the entertainment and toy sectors becomeincreasingly interconnected, some Hong Kongfirms are working with entertainment companiesto develop toys that can be marketed throughmedia and entertainment channels. Someentertainment firms are developing content thatis inspired by a toy. This “fusing of interests”is becoming a popular strategy to create newmarkets for existing products and to create newproducts that can be sold into existing markets.Hong Kong toy manufacturers that have teamedup with US entertainment firms, have hadmixed results, but Hong Kong firms have gainedvaluable experience and there is an ongoingappetite to continue the strategy of crossovermarketing.• Hong Kong firms are increasingly focusingon specialised niches to make themselves“indispensable” for specialised components orproducts. Some firms, such as Jetta, have longmade engineering excellence their niche, othershave more recently either created niches, suchas V-Tech, or have moved into niche marketsand ended up dominating them by being betterat branding or design or both, such as MayCheong.• Hong Kong firms are also more focused on doingdeals with the big toy retail firms that involveinnovative, original, and high quality productswhich are certified as being non-counterfeit.Hong Kong firms have battled to protect theirintellectual property, and a lesson learned is thatit is more effective to take action against theimporters, distributors, and retailers of counterfeitproducts who sell outside of China than it is totake action against manufacturers that infringeon intellectual property rights in China.Case Study – Silverlit Toys Manufactory LimitedSilverlit is a Hong Kong-based family-owned andmanaged company engaged in OEM, ODM, andOBM toy production. Established in 1977 withfive staff and a few old machines located in 2,000square feet in Chai Wan, Silverlit now does mostof its manufacturing in a 750,000 square footfactory in Dongguan and has several thousandworkers. The company does no manufacturing inHong Kong. Silverlit has branches in the US, UnitedKingdom, Germany, France, Netherlands, andSpain. In China it has offices in Beijing, Shanghai,Guangzhou, Chengdu, and Wuhan. By 2010,Europe and the US each represented around 40 percent of Silverlit’s global sales, China less than 10 percent of sales, and the rest of the world the balance.Initially focused entirely on OEM, the firm nowderives about 10 per cent of its revenue from OEMwith most of the firm’s business being concentratedon the development and manufacture of its ownbrands of toys.The company’s first big breakthrough was witha press-and-go mechanism for a car toy thatits engineers developed internally in 1984. Themechanism was different from the pull-back andwind-up mechanisms widely used in toys at thattime. Silverlit patented the innovation and thecompany has since sold 100 million pieces foruse in a wide variety of products. In 1996 Silverlitcame out with the “TurboZ,” a remote controlcar that contained a microprocessor that made itprogrammable. The TurboZ appealed to a widerangingage group and sold one million piecesin the first year. Similar higher-value productsfollowed, including an interactive robotic dog called“i-Cybie” which was launched in 2001 and becameanother big seller. The i-Cybie demonstratedSilverlit’s technological capability being the firstmass produced toy that used advanced voicerecognition technology.

92In 2006 the company launched “PicooZ,” a microsizedremote control toy helicopter for indooroperation. The first shipment of 2.5 million unitssold out as soon as they hit stores. The PicooZhas been hailed as “changing the world of playby creating a new segment of high-tech toy thatappealed to customers from office girls in Japanto grandparents in Europe.” 175 Silverlit teamed upwith Canada’s Spin Master Limited, which sellsthe PicooZ under Spin Master’s Air Hogs brand inNorth America, while Silverlit sells it in the rest ofthe world. Silverlit deepened the relationship withSpin Master by agreeing to produce 60 per cent ofAir Hogs toys thereby becoming Spin Master’s mainOEM partner.Seeing the potential for crossover between thetoy and entertainment industries, Silverlit enteredinto a partnership in 2007 with a Mainland Chinamedia company to produce a cartoon series entitled“Golden Hero.” Golden Hero is broadcast by manylocal television stations in China and the firm hasfound that sales of the toys that are featured inthe series increase by between 10 and 20 per centin markets in which the series is shown each timethat the series is aired. In 2009, Silverlit bought theFrench pre-school brand Ouaps, whose emphasison innovative technology and quality fitted wellwith Silverlit.Issues and ChallengesSilverlit has faced a number of significant challengesduring the past 30 years. The global economicdownturn particularly affected some of Silverlit’smajor markets, such as the US, the UK, and Spainand recovery has been slower than Silverlit wouldlike. There has been a noticeable decrease in ordersand buyers are placing smaller and more frequentorders which makes production planning moredifficult for Silverlit.175 ESA Project Interview with Sarah Monks, 2010-05-18, quotingSilverlit managing director Kevin Choi Kei-fung.Keeping production costs down in the face ofincreases in minimum wages (for both Silverlit andsuppliers), appreciation of the RMB, and increasesin other input costs is an ongoing challenge.Finding sufficient numbers of workers is a problemas it is for all manufacturers in Dongguan. This isparticularly true for managerial talent because thecity lacks higher education institutions. Althoughwages in toy factories around the PRD are similar,other factors such as the working and livingconditions are becoming more important as workerscan easily get information on conditions via mobilephones or the internet.Another challenge has been an inability to raiseprices to offset cost increases. Silverlit doesn’t seethis situation changing in the near term as parentsbuy cheaper toys for their children, and the bigretailers squeeze manufacturer margins to preservetheir own. Still another challenge has been to stayahead of Chinese toy companies as they beginto invest more in innovation. Silverlit expects thatMainland firms will soon compete for orders fromlarge retailers in big markets through design andvalue added features.Silverlit has found intellectual property infringementto be a big issue. Several years ago the firmstarted losing orders for the PicooZ in Europe andelsewhere to counterfeit products. Although thefirm has noticed a genuine commitment on thepart of China’s Central Government to improveintellectual property protection, it finds enforcementat the local level lacking.Selling in the China market requires 3C qualitycertification. This certification is difficult, timeconsuming, and costly for firms like Silverlit toobtain. However, in many cities in China, many lowquality products have obtained 3C certification,suggesting that their quality is on par with Silverlit’s,and making it difficult to differentiate in theselocations. While certification standards are strict inShanghai and Beijing, and reasonably strict in citieslike Nanjing and Hangzhou, the process is clearlyless stringent in most other cities in China.

93Company StrategySilverlit constantly evaluates its position and adjustsits business model and product development effortsaccording to market forces. When the market wassimpler, the firm made simple and small toys. Whenthat market became saturated, the firm beganmaking more complicated electronic toys. Whenthe market for electronic toys became saturated,the firm shifted to remote control toys such ascars and helicopters. When the market for remotecontrol cars started to become saturated, the firmturned its focus to licensing toys connected to theentertainment industry, and when that marketbegan to get competitive the firm developed itsown brand of toys that could be marketed throughentertainment and media channels that it eitherowns, has a stake in, or has significant control over.In response to cost pressures, Silverlit is relentlesslyfocused on improving production efficiency, onimproving and simplifying product design, and onsimplifying management processes. As a firm thatrelies heavily on labour, Silverlit also pays closeattention to the needs of its workers. This hashelped the firm to understand that workers havecome to expect better working conditions, leisure,and development opportunities. In response, Silverlithas opened a library for them, provided additionalentertainment facilities, and put in place systemsto understand and respond to issues that areimportant to workers.In an increasingly competitive business dominatedby a few large retailers with significant buyerpower, Silverlit has found that the only way toprosper is to offer products with features othersdo not have, and which justify a price premium.Silverlit differentiates its products from those of itscompetitors by trying to be more creative than thecompetition. In 1988, Silverlit established an internaldesign team so that innovations, creative thinking,and advances in technology could be appliedacross different products from remote-controlledmodel cars, to model railways, boats, helicopters,and other electronic toys. This enabled the firm tocapitalise on its research and development effortsand facilitated the development of its own brandedproducts.Silverlit’s “innovation mindset” applies to everythingthat the firm does and it has found that often themost successful innovations are neither very hightechnor sophisticated, but result from simple andcreative thinking that is constantly applied. Silverlitcreated a new segment by producing toys withbetter quality and features than those in the lowendmass market, but more affordable than thosepurchased by serious hobbyists and toy enthusiasts.This strategy created a market with large volumesand good margins. Silverlit is innovative even whenit comes to the packaging of its products. Theaim is to make toys that are as different from thecompetition, and better in every aspect, rather thanto follow competitors or market trends.Silverlit tightly controls the quality of its products.In the early 1990s, Silverlit became the first toymanufacturer in Asia to qualify for ISO 9001certification. This demonstrated the firm’scommitment to quality and enabled it to obtainprice premiums from the market. In addition,most of the customers that Silverlit targets won’tpurchase low quality substitutes even if they aresignificantly cheaper. This has helped Silverlitdefend its position against Mainland Chinesecompetitors that have lower costs than Silverlit,but offer toys that are poorer in quality and unableto meet the quality and safety standards of thelarge retailers.To protect its intellectual property, Silverlit initiallytook legal action against the firms that weremaking counterfeit products in China. This provedto be costly, time consuming, and impractical dueto lack of local enforcement. Eventually Silverlitfound threatening legal action against the buyersof the counterfeit products more effective becausethe buyers tended to be located in markets wherethe laws were clearer and more easily enforced.The issue has not been fully dealt with, however,and there are many firms that still make copycatproducts that steal potential sales from Silverlit.

94Silverlit is determined to operate mostly as anOBM company. In addition to its pioneering newtechnologies and segments, Silverlit has alsolinked its toys to entertainment products. In 2007,Silverlit entered into a partnership with ShanghaiCharacter License Administrative Company Limited(SCLA), an established Mainland publisher of titlesthat include popular comics, and the owner ofa television production house to produce a 52-part series called “Golden Hero.” Billed as thefirst original Chinese hero-themed children’stelevision show, it was screened on some 45Mainland television stations from 2008 to 2009,with a second series in production in 2010. It hasalso been broadcast in Taiwan. SCLA comes upwith the storylines while Silverlit develops relatedtoy concepts. The ultimate goal is to launch a toybrand that is developed and tested in China intothe US and European markets.Silverlit is increasingly manufacturing selfbrandedtoys, but also produces under licenceand co-brands some of its products. The idea for“Golden Hero” came from the relationship thatSilverlit has with Marvel to produce toys underlicense in support of the Spiderman, Ironman,and Cars movie franchises. By signing with Marveland producing licensed products, Silverlit hopesto improve the firm’s image and thus lead toincreased orders for products that carry the Silverlitbrand. In North America Silverlit co-brands itsplanes with Spin Master because in that marketSpin Master is a more recognised brand andoffers very professional after-sales service. Silverlittherefore puts two brands, its and Spin Master’s,on the products. Silverlit uses its own brand inother countries where there isn’t a dominantbrand already.In response to the changing order patterns fromcustomers due to the global economic crisis of2008/09, Silverlit is attempting to build closercontact with its customers through its offices inthe US and in Europe. Staff in those offices makefrequent personal contact with customers to getorders confirmed, to try and increase orders, andto find out what customers are thinking and howtheir needs are changing. Most competing firmsdo not have offices in the US or Europe and donot have such tight contact with their customers.Silverlit has found a face to face strategy to bemore effective in securing orders even as customerbudgets tighten, the firm still manages to securecustomer orders.Silverlit’s China strategy draws on more than 10years of retail experience in that market. The firmstruggled to make significant sales in the ChineseMainland when there was little intellectual propertyprotection, incomes were low even in the majorcities, and the regulatory environment favouredMainland China-owned manufacturers. Now thatthe Chinese Government is addressing these issues,Silverlit is finding greater opportunity in China andis opening more sales channels. Presently, the firmhas approximately 400 sales stands in China, mostlyin large department stores in Beijing, Shanghai,Guangzhou, Chengdu, and Wuhan. Silverlit doesnot expect to expand Chinese sales very quickly,but it does expect sales to grow steadily andbelieves that China represents an important futuremarket. Silverlit plans to enter second-tier and thirdtiercities as intellectual property protection andeconomic conditions improve in those cities.Future PlansHaving conquered the skies, Silverlit is now set onbuilding a global brand originating in China. Thepioneering branding strategy that Silverlit enteredinto with SCLA could help transform Silverlit into amedia-focused and content-driven global toy brand,like Bandai in Japan. Although the focus with SCLAis currently on the market in the Chinese Mainland,there is a plan ultimately to expand the strategy intoother markets such as the US and Europe.The Chinese market, which now accounts for lessthan 10 per cent of Silverlit’s business, is a majorfocus for the future. The firm sees enormousopportunity as the market matures, as income levelsrise, and as intellectual property rights are betterenforced.

95Silverlit plans to continue manufacturing inDongguan even though labour costs might behigher than elsewhere because the firm’s productsare quite sophisticated and they depend heavily onupstream manufacturers that are also located inDongguan or nearby.In the past, children aged 10 and above tendedto be interested in electronic toys and games.Today, children between the ages of 4 and 10 areinterested in these products. To cater to this shift,Silverlit plans to invest more into research anddevelopment for toys for a younger profile and willlikely expand its present team of 200 researchers.Lessons from the Silverlit CaseThere are a number of lessons that can be learnedfrom the Silverlit case.• Changing customer buying patterns can createproblems in trying to plan for the order ofraw materials, the hiring of workers, and thescheduling of production.• To combat cost increases, firms must focus onimproving production efficiency, on improvingand simplifying product design, and onsimplifying management processes.• Increasing wages alone is no longer sufficient toattract and retain workers in China. Other factorssuch as the general working and living conditionsplay an increasingly important role in determiningthe employment choices of workers.• Workers in China have greater access toinformation than before. Firms will need to moreclosely monitor employee desires in order to findand retain capable workers.• Increasing product prices in order to maintainprofit margins is not easy to do during tougheconomic times. This may mean that costincreases can’t be offset in the short-term bycorresponding revenue increases.• It is hard to make profits when large and powerfulbuyers are able to push down margins. Bigretailers that hold significant bargaining power willsqueeze manufacturer profit margins so as to notreduce their own profit margins.• In markets with significant buyer power, sellersthat have clear quality, technological, design, andservice advantages will perform better and have agreater capacity to “hold the line” on prices andmargins than those that do not.• Customers that value quality won’t purchaselow quality products even if they are significantlycheaper. This represents opportunity for qualitymindedproducers.• Competing firms that presently follow a strategyof imitation may quickly evolve to follow a strategyof innovation once they gain greater experience.• SMEs can create long-term sustainablecompetitive advantages through productdifferentiation and by being more innovative andcreative than competitors.• Having invested a great deal of time andmoney in doing research and development,SMEs may find that the results of their effortsare appropriated by firms that are prepared tomanufacture counterfeit or copycat products.• Taking legal action against firms that makecounterfeit products may prove to be costly,time consuming, and impractical, but taking orthreatening legal action against the trade buyersof the counterfeit products may be a moresuccessful strategy.• The commitment on the part of the ChineseGovernment to improve intellectual propertyprotection does not necessarily mean thateffective action is taken to protect intellectualproperty rights at a local level.• Some Hong Kong firms are finding it easier toprotect their intellectual property in larger citiessuch as Shanghai and Beijing in China whereintellectual property laws are more carefullymonitored and enforced. This makes it relativelyeasier for firms that rely on intellectual propertyto compete in these locations.• SMEs can develop niches by identifying marketsin between the low-end mass market and thehigh-end market and by producing productsthat are better quality and have more featuresthan those in the mass market but which aremore affordable than those purchased by seriousenthusiasts.

96• Specialised products are not as vulnerable tomarket fluctuation as general products, and theytend to have a higher profit margin than generalproducts.• By being the leading manufacturer of a nicheproduct, the SME becomes more importantto customers that serve end markets for thoseproducts. This makes it difficult for othercompanies to compete with the firm.• SMEs that focus on specific niches are likely tohave fewer competitors, be more flexible, be ableto make decisions faster, more quickly adopt newtechnologies, and respond quicker to marketchanges.• SMEs should constantly evaluate their positionand adjust their business model and productdevelopment efforts in line with changes inmarket forces.• Applying for ISO 9001 certification demonstratesthe firm’s commitment to quality and may enableit to extract price premiums from the market.• SMEs should find ways to continuously innovateand improve their products and processes.Investing in ongoing research and developmentis the cornerstone of innovation, but often it isthe case that the most successful innovationsare neither very high-tech nor sophisticated, butresult from simple and creative thinking.• Establishing an internal design team may leadto innovations, creative thinking, and advancesin technology being applied across differentproducts, which maximises the value of investingin such a team.• SMEs that focus on OEM will face difficultcompetition.• SMEs may be able to stay ahead of thecompetition by focusing on OBM because brandsare harder to imitate and have unique value.• SMEs should consider partnerships with firmsthat possess skills, capabilities, or resources thatthey don’t when there is a clear strategic casefor doing so. Co-branding is one example of apartnership to leverage such capabilities.• Manufacturing products under licence mayenhance the overall profile of the firm and leadto increased orders for other products that thefirm produces.• Toy brands can be developed by partnering withentertainment companies that create and controlcontent that is distributed via television, theinternet, or other mass media.• SMEs should strive to keep in close contact withits customers through offices in locations inwhich there are significant sales. Face-to-facecontact can be very effective in securing customerorders even when customer budgets are tight.• Hong Kong SMEs will find it easier to sell inthe Chinese Mainland as intellectual propertyprotection improves, disposable incomes rise, andregulatory environments that favour Mainlandownedmanufacturers give way to a more levelplaying field.• As intellectual property protection and economicconditions improve in China’s second-tier andthird-tier cities, SMEs will find it easier to sell intothose cities.

97Strategies to Meet the Challenges Facing Hong KongManufacturing SMEsThe challenges that Hong Kong manufacturingSMEs face are daunting. In order to survive andto thrive, the SMEs will have to deal with externalchallenges as well as internal managementchallenges. The most successful companies will bethose that ask and answer the difficult questionsand chart a clear strategy that allows them to dealwith both the external and internal challenges. Thefollowing are strategies that the SMEs may employto improve their prospects and the questionsthey need to ask and answer going forward. Theanswers to some of the questions may differ fromindustry to industry and from firm to firm. The keyis that the SMEs develop a clear and coherent setof strategies and policies to navigate difficult anduncertain terrain. Leaving matters to chance or toa purely reactive approach is a recipe for disaster,while firms that develop coherent strategies maywell be able to profit from changes in the externaland internal environments.One feature of existing surveys is that even thoughthere is much discussion of the difficulties that HongKong’s manufacturing SMEs face, the majorityof responding firms have made only incrementalchanges to their strategies as of yet. The dominantresponses have been improving relationshipswith existing customers, increasing developmentcapacity, seeking incremental means of cuttingcosts, and trying to expand sales in the ChineseMainland. Changing lines of business, relocatingaway from the PRD, shifting from OEM to OBMproduction, and other more radical approaches arenoticeable largely by their absence. This may meanthat the challenges are not as great as have beensupposed or that much greater changes will berequired in the future for the SMEs to survive andthrive.The following sets forth strategic options fordealing with the external and internal challengesthat Hong Kong manufacturing SMEs face.The options list many types of information andanalysis that SMEs should undertake in order toformulate and implement their strategies. Giventheir limited resources, SMEs will have to prioritisetheir investigations. Even so, it is hard to imaginethat any company can succeed without a basicunderstanding of their industry’s major productsand segments, the major types of customers andtheir needs, the major types of competitors andtheir advantages and disadvantages, and the firm’sown ability to execute the desired strategy and runa business. These need to be the main priorities.Beyond that, it is important that managers at leastunderstand what the other items on the followinglists are so that they do not get blindsided.The strategic options are also included in the “SMEAdvisory Kit” which accompanies this report.“The SME Advisory Kit” also provides suggestionsas to the “how to” steps appropriate to thedifferent options and investigations. The latterare not included in the base report due to spaceconsiderations.Strategies to Deal with ExternalChallengesThere are a number of strategies that Hong Kongmanufacturing SMEs may employ in order to dealwith the challenges they face. They can broadly bedefined as:• Cost reduction strategies• Differentiation strategies• Labour market strategies• Business model strategies• Geographic market strategies• Regulatory and policy-related strategies• Exit or consolidation strategiesThese strategies are not mutually exclusive. In fact,companies will have to make choices in all of theseareas and they may choose to keep the status quoin some areas while making changes in others. Wedo note that the managers interviewed for thisproject were in general agreement that across theboard status quo strategies (i.e. changing nothing)was unlikely to lead to success for most of HongKong’s manufacturing SMEs.

98Cost Reduction StrategiesStrategies to deal directly with cost increases caninclude the following:• Improve efficiency within the factoriesImproving efficiency within the factories couldinvolve improving factory layouts, optimisingprocess flows, providing additional training forworkers, and improving management practices.Many SMEs could work to install modern cellularand team production processes, reduce thephysical footprint of activities, debottleneckprocess flows, and more sharply define worktasks for greater efficiency.• Automate production processesAutomating production processes is a way toreduce the overall labour content, reducingexposure to labour shortages and increasingwage rates. This can only be done if theprocesses can effectively be automated and ifthe capital required is not beyond the means ofthe SMEs. As labour becomes more expensiveand scarce, companies should identify laboursaving automation that would not have madesense in China in the past. This could includenot only automation of individual manufacturingoperations, but of materials handling andpackaging as well.• Improve efficiency in logistics, distributionand other activitiesImproving efficiency in logistics, distribution,and other activities can often reduce total costsmore than improvements in manufacturing.A comprehensive approach to cost reductionprovides the best opportunity to offset costincreases. Logistics and distribution costs are oftenhigher than actual production costs. SMEs shouldundertake an examination of their total costpicture, identify key cost elements (not just in theactual manufacturing), and develop cost controlstrategies in response.• Outsource business processesSMEs often face inefficiencies in businessprocesses, such as accounting, payroll, informationtechnology, warehousing, and others due to a lackof scale and specialised resources. Outsourcingsuch business processes can often lower the costsfor SMEs. In some cases, such services can bepurchased in bulk by groups of firms coordinatedby industry associations.• Relocate to other places in ChinaAs costs rise in the Pearl River Delta, manufacturingSMEs have the option to relocate production toother parts of China in which costs are lower. Thiscan only be done effectively if the relevant supplychains can be extended to the new locations andif the Hong Kong firms can manage farther afieldthan the PRD. SMEs should investigate wheresupply chains might support new productionlocations and should follow the moves of largecompanies that could bring their suppliers withthem if they relocate.• Relocate to other places in South orSoutheast AsiaRelocating to other countries, mostly probably inSouth or Southeast Asia can be another optionto combat rising costs in China. However, thiswill only be feasible if the infrastructure, supplychains, labour force, and regulatory environmentare suitable. Again, this also requires the HongKong firms to manage in a new environment thatmight not be as accessible as the PRD.• Relocate along with similar firmsMuch of the discussion of potential relocationof Hong Kong companies assumes that theymove as individual firms. In some industries,it might prove beneficial for groups of firmsto move simultaneously in order to ensurea critical mass exists in the new location toattract suitable suppliers. There are examplesof such group relocation in the Italian footwearindustry and in mobile handsets, where agroup of firms moved from Shenzhen toHuizhou with the support of the Huizhou and

99Central Governments, who set up research andtesting facilities.Differentiation StrategiesAnother means of dealing with cost increases is todifferentiate in order to gain some pricing flexibility.Approaches to differentiation include:• Improve product qualityCustomers often are willing to pay higherprices for demonstrably higher quality products.Depending on the industry, quality may bedefined by precision craftsmanship, speed,reliability, product life, fashion or design content,attractive appearance, image, incorporation ofmore advanced technologies, or customisation.The challenge is to provide higher quality thatthe customer values, can be achieved in a costeffective manner, and is difficult to imitate. SMEsoften have a hard time developing the capabilitiesto produce products with demonstrably higherquality than those of competitors. It is alsonecessary to find ways of demonstrating superiorquality to customers.• Improve services to customersImproving services to customers can includeproviding just in time inventory management forcustomers, providing design services, providingrapid turnaround and delivery, and providingreliable supply. To the extent that the firm candistinguish itself from its competitors, it may beable to obtain some pricing flexibility. The key isthat the SME view itself not just as producing aproduct, but as producing value for the customerthat could go well beyond the product itself andcould involve special delivery conditions, inventorymatching, designing, and other activities as well.• Move from OEM to ODM or OBM productionMoving from OEM to ODM or OBM productioncan allow manufacturing SMEs to distinguishthemselves and obtain better prices. However,ODM requires the firm to invest in designcapabilities and OBM production requires thefirm to invest in branding, marketing, anddistribution. This in turn requires substantialresources and capabilities that most Hong KongSMEs that started in OEM production do notpossess. To brand successfully, the companymust either have or bring on board people withthe appropriate marketing skills, must engage inconsumer research, and must develop a clear andconsistent message that is fully backed up by thequality of the product and the entire purchasingexperience of the consumer (including choice oflocations, types of outlets, packaging, displays,price points, and promotional material).• Tailor strategy to serve particular nichesBy definition, SMEs generally cannot supplyall types of customers. As a result, it is oftenbetter for SMEs to tailor their strategy to servingparticular niches, gaining distinctiveness andthe ability to differentiate by understanding andserving the needs of customers in the targetniches better than competitors. In order to carryout this strategy, the SME must develop a deepunderstanding of the niche, their precise needs,and cost effective ways of meeting those needswhile distinguishing itself from competitors.• Supply high value market segmentsHigh value niches, with customers that may beless price sensitive than the mass market, provideparticular opportunities for pricing flexibility,but requires a firm to develop the capabilities toserve these markets. The idea is that high valuesegments generally have buyers that do notpurchase on price alone. Appealing to customerswho want high performance, a specific image,exclusivity, special features, or other non-pricefeatures again requires products that meetthe relevant criteria and companies that cancommunicate their appeal clearly.

100Labour Market StrategiesObtaining and retaining labour and managerialtalent are major challenges for Hong Kongmanufacturing SMEs. Labour market strategies mayinclude the following:• Engage in more active recruitingIn the past, many Hong Kong manufacturing SMEstook a relatively passive approach to recruiting,hiring people who came to apply or workingthrough a government employment agency.Increasingly, firms are finding they must becomemore proactive in attending job fairs, workingthrough existing employees, and engagingadditional sources of information or access topotential employees. Even SMEs can no longer relyon others to attract the personnel that they need.• Understand that high turnover is costlyHigh turnover often imposes costs in terms ofrecruiting, training, inexperience, learning time,and disruption of teams. Often SMEs do notunderstand the full cost of high turnover, andtherefore may understate the value of doingwhat is necessary to retain workers. SMEs shouldcalculate the cost of recruiting, processing,training, bringing up to speed, and dealing withthe departure of workers. In many cases, theresults will be surprising. This means that SMEsneed to be able to judge very quickly whether anemployee is a good fit and take steps to ensurethat valuable employees stay.• Increase wagesThe overwhelming attraction for employees inthe manufacturing sector in China is wages.Thus increasing wages is always one mechanismto obtain workers. This of course is difficultfor companies that already operate with lowmargins. However, some companies have foundthat they have been able to reduce turnoverthrough higher wages and therefore can offsetthe higher wages at least in part throughproductivity gains. The wage / job satisfactiontrade-off is a difficult on for SMEs to judge. Thekey is that they try.• Provide better working environmentsAlthough wages may be the most importantworker attractor, increasingly the entire workingenvironment, including working conditions,canteen facilities, leisure opportunities, athleticfacilities, and other amenities can be decisive ina company’s ability to attract and retain workers.Again, while adding cost, improvements in theworking environment can be a competitiveweapon in the quest to attract and retainemployees. This is particularly true as workers inthe Chinese Mainland have higher aspirationsand more employment alternatives inside andoutside the manufacturing sector.• Institute effective performance evaluationschemesNothing discourages workers more than anineffective evaluation scheme and nothingencourages workers more than an effectivescheme linked to compensation. Managersshould ensure that they have good employeeevaluation systems in place to help motivateand monitor workers. While many firms viewworkers as interchangeable cogs and use simplenumerical output counts to evaluate and rewardemployees, others are starting to get moreout of employees by taking a more systematicapproach to evaluating attitude, cooperativeness,willingness to work in teams, and for suggestingimprovements.• Shift production to sources of labourAs options for young workers improve in China,especially in the interior, some firms will find iteasier to attract and retain labour if they moveproduction closer to the sources of workers.This will be aided by improving infrastructureand perhaps by incentives to move into China’sinterior, but raises the difficulties associated withmoving away from established supply chains andmanaging at a greater distance from Hong Kong.In the future, as Guangdong appears to wish toshift some businesses out of the PRD, it couldprove fruitful to locate in places where workerscan live at home with their families and still have

101manufacturing jobs, which is still not the case inlarge portions of China’s interior.• Develop managerial talent from the ChineseMainlandMany Hong Kong manufacturing SMEs preferto hire managers from Hong Kong. However,the supply of trained Hong Kong managerswith manufacturing experience is declining. Oneobvious potential source of managers is theChinese Mainland. Here the best approach maybe bringing in relatively young managers anddeveloping them within the organisation. Thechallenge is that it may be difficult to retain suchpeople, who may leave to work for competitorsor set up competing companies of their own.This may be unavoidable. The key is likely to behow the company tries to instil loyalty and asense of belonging within the firm.• Bring in managerial talent from elsewhereIn addition to Hong Kong and the ChineseMainland, Hong Kong SMEs should considermanagers from other locations, such as Taiwan,Korea, Singapore, Malaysia, and other places inSoutheast Asia. Several of these economies havemore of an ongoing manufacturing tradition thanHong Kong and managers from these locationsmay be less likely to start up competing firms oftheir own in China. This may require SME ownersand managers to travel more and look beyondtheir traditional sources of managerial talent.• Share wealth with management talentProviding senior managers with some stake inthe business, such as rewards linked to companyperformance or even an ownership share, canprovide motivation and may make it easier toretain key personnel. This may be difficult in SMEcorporate cultures where often only a singleindividual has a real stake in the success of thefirm. The trouble is that in such structures anyonewith sufficient talent will soon go elsewhere orstart up on their own.Business Model StrategiesChanges in business models involve changingthe activity mix of the company in order to focuson the activities in which the company can buildcompetitive advantages and leave other activitiesbehind. Examples of such strategies include:• Shift from manufacturing to outsourcingproductionIf the Hong Kong manufacturing SMEs believethat others, such as firms from the ChineseMainland, will have an unassailable costadvantage, or that they will not be able to obtainsuitable margins through manufacturing, theymay shift from manufacturing to outsourcingproduction to others. In such cases, the HongKong SME would use its knowledge of marketsand contacts with customers to sell its outsourcedproduction.• Become a trader or agent for othercompaniesThe extreme case of outsourcing would bemanufacturing SMEs transforming themselvesinto traders or agents for other companies.Again, they would use their market knowledgeand customer relations to sell the traded goods.Presumably they would be sourcing from otherHong Kong firms or firms from the ChineseMainland in most cases, though in some sectors,finding sources in South Asia or Southeast Asiawould also be desirable.• Become a subcontractorThe opposite approach would be to becomea subcontractor for a larger company, lettingthe larger company deal with powerfulbuyers, export-related regulations, and otheradministrative matters. This approach has beenused by a number of companies that no longercan or wish to deal with the administrativeburden of being an exporter themselves soinstead supply other companies that have theadministrative capacity, financial strength, andaccess to customers to continue to export.

102• Engage in forward integration into retailingor sell direct to end customersWhile most Hong Kong manufacturing SMEs sellto OEM customers, and thus have little contactwith end consumers, others have forwardintegrated into retailing. The advantage is thatsuch companies are less beholden to powerfulretail chains and can set their own prices.However, retailing requires skills and expertisethat is likely to be beyond the capability of mostmanufacturing SMEs to master, particularlysince most SMEs have had little direct contactwith end consumers. The most likely places forsuch retail businesses are Hong Kong and theChinese Mainland, where Hong Kong productscan still obtain a premium in some sectors. SMEswishing to follow this strategy need to ensurethat they have or bring in sufficient expertise torun retail operations, with the associated siteselection, retail rentals, licensing, accounting, andpromotion activities associated with retailing.Geographic Market StrategiesMost Hong Kong manufacturing SMEs produce onan OEM basis for eventual sale in one or a smallnumber of OECD markets. The downturn in thesemarkets has meant that some companies have hadto seek ways of reaching end consumers in othermarkets. The choices here are as follows:• New OECD marketsDiversification to new OECD markets is helped bythe fact that OECD markets in aggregate are stillbe far the world’s largest markets, accountingfor well over half of global consumption. Suchdiversification is hindered at present by the factthat the global downturn has hit all the majorOECD markets. In addition, serving new OECDmarkets often requires firms to compete againstalready relatively well-entrenched competitorsand supply chains.• The Chinese MainlandThe Chinese Mainland is clearly the world’smajor growth market at present. However,China only accounts for under 6 per cent ofglobal consumption today. In addition, China’srelatively low per capita income means that theChinese market has a different segment structureand often different consumer requirementsthan the markets that usually absorb the goodsof Hong Kong’s manufacturing SMEs. In orderto serve the Chinese Mainland market HongKong manufacturing SMEs must develop theirown distribution networks or find others thatcan distribute for them. Finally, the Hong Kongfirms have to compete with firms from theMainland without the advantage that the HongKong firms often have in international markets,that is knowledge of international tastes andrequirements. All of this makes selling in theChinese Mainland a potentially rewarding, butdifficult, undertaking.• Other developing country marketsOther developing markets, including those inSouth Asia, Southeast Asia, Latin America, theMiddle East, and Africa, are expected to growfaster than OECD markets over the next severalyears. Diversifying markets to include suchcountries is another potential avenue for salesgrowth. The challenge here is that these marketstend to have obstacles in logistics, distribution,and sales systems that have to be overcome forthem to be viable markets for the Hong KongSMEs. Presumably the easiest path for salesin these markets is to sell to OEM customers,traders, and agents that already have distributionand sales in these markets.Regulatory and Policy-related StrategiesHong Kong SMEs operating in the ChineseMainland need to have strategies to deal with theregulatory and policy environment in China. Theseinclude:

103• Strategies to deal with environmental andproduct safety regulationsHong Kong manufacturing SMEs have littlechoice but to ensure that they are in fullcompliance with environmental and productsafety standards. This is necessary to operate inHong Kong and the Chinese Mainland and willbe necessary in many cases to satisfy customersas well. Companies that believe that adheringto such standards puts them at an untenablecompetitive disadvantage will have to consideroutsourcing some operations. For many pollutingindustries, there are cleaner fuels, cleanertechnologies, or ways of handing effluent in amore environmentally sensitive way than is doneat present. In some cases, joint investments inclean technologies by co-located companies, orrelocation to specialised industrial parks with theright infrastructure could provide solutions.• Strategies to deal with administrativerequirementsThe administrative burden on Hong Kongmanufacturing SMEs operating in the PearlRiver Delta region is increasing. This is unlikelyto change anytime soon. In fact, if anything theadministrative burden is likely to increase. HongKong companies will have to carefully budgetfor the administrative costs and may find thatoutsourcing some record keeping and relatedfunctions may be cost effective. Intervieweesindicate that more and more governmentdepartments are visiting factories in the ChineseMainland and having senior managementon hand to meet with officials from thesedepartments is disruptive to the enterprise. EvenSMEs may be forced to hire specific governmentrelations personnel to take on part of the taskof dealing with officials. Early planning so thataccounting and reporting systems within thefirm also gather the information required bygovernment departments could also help reducethe administrative costs.• Strategies to deal with policies to restructureor upgrade local economiesHong Kong companies often view themselves aspotential victims of policies designed to upgradethe economy of the Pearl River Delta. While suchpolicies may cause disruption to many companies,they are unlikely to be reversed. Hong Kongmanufacturing SMEs need to determine if thereare ways to actually benefit from such policiesby entering favoured industries, by engaging infavoured activities (such as branding or researchand development), and need to avail themselvesof financial, technological, and other supportthat may be provided as part of the upgradingpolicies. If none of this is possible, the HongKong manufacturing SMEs may have to considerrelocating to an area where their industry issupported. It is important that SMEs understandprecisely what different levels of governmentdesire in terms of industrial structures andactivities and to portray their own operations inthis light. Unfortunately, the Chinese Governmenttends to take a sector by sector approach ratherthan a technology by technology approach. Thushigh technology solutions in traditional industriesmight not find favour while labour, resource, andenergy-intensive process in “high technology”industries might.• Strategies to leverage policies in support ofSMEsB o t h t h e H o n g K o n g a n d G u a n g d o n gGovernments have enacted a range of policiesto support SMEs. Hong Kong manufacturingSMEs should ensure that they are knowledgeableabout such programmes and can use theprogrammes where appropriate to their benefit.These include programmes that provide financialsupport; information on markets, technologies,and policies; support for upgrading; trainingsupport; and other programmes. Of course, SMEsneed to do a cost-benefit analysis to ensure thatthe administrative costs of participation in suchprogrammes do not outweigh the benefits.

104• Strategies for relationship managementMany owners and managers of Hong Kongmanufacturing SMEs operating in the PRD donot spend sufficient time in the PRD to get toknow local officials as well as their Mainlandcompetitors. An active strategy of governmentrelations will help Hong Kong SMEs betterunderstand rules and regulations and howthey are likely to be enforced. A number ofinterviewees commented that too many HongKong entrepreneurs expect to be able to dobusiness in the Chinese Mainland, produce inthe Mainland, sell in the Mainland, and in otherways leverage the Mainland without spendingmuch time in the Mainland themselves. Suchan approach will always leave Hong Kongentrepreneurs a step behind their Mainlandcounterparts when it comes to anticipating andunderstanding the nature of changing rules andregulations and precisely how they are going tobe administered.Exit or Consolidation StrategiesGiven the severity of the forces influencing HongKong manufacturing SMEs, we expect that therewill be significant consolidation and / or exit in somesectors. Approaches include:• Sell out or shut downHong Kong SMEs that find their positionuntenable and prospects bleak may choose toexit by selling out (if a buyer can be found) orsimply shutting down. While a last resort, suchoptions must be assessed from time to time. Thekey here would be working with new owners orlocal governments to ensure an orderly transferor closure and minimising the losses incurredduring the exit process.• Change lines of business completelyFor some firms, exit in one sector may be thefirst step to developing new businesses in othersectors. The key here is to ensure that thereis a market for the new product or service,that the company can develop some distinctcompetitive advantages, and that it has or canobtain the resources to make the entry work.In other words, any SME considering changinglines of business should go through all the stepsindicated for selecting businesses to be in andfor developing strategies for the new businessesdescribed below.• Consolidate the sector by acquiring otherfirms or investing to beat them in themarket place and grow organicallyThere is likely to be significant consolidation inindustries currently populated by Hong Kongmanufacturing SMEs. Some companies maychoose to take the initiative to consolidate theirsector, at least in part, by acquiring competitorsor by investing to grow by beating them in themarketplace. This approach would require theresources to make the acquisitions or investmentsnecessary. Sectors that are in a state of flux maybe ripe for such moves for the right company.We should remember that Hong Kong’s largecompanies started as small companies andgrew by recognising and acting on businessopportunities. In difficult times, strong firms maybe able to gain competitive positions that they willretain when times get better.

105Strategies to Deal with InternalManagement ChallengesThe vast majority of SMEs that are startedaround the world fail. The main reasons for thesefailures are not challenges posed by the externalenvironment, but rather shortcomings in internalstrategies, management, operations, and financialcontrols. In many cases, these shortcomings aredue to limited resources, stretched managementpersonnel, and incomplete strategies or businessplans. Some of the main internal challenges SMEsface:• Selecting businesses in which to compete• Formulating compelling strategies or businessplans• Understanding customers• Understanding competitors• Developing clear competitive advantages• Financing operations and financial management• Administering and Managing the firm• Keeping up to date on market, technological,and managerial developments• Marketing and selling to existing and potentialcustomers• Reducing dependence on individual customersand suppliers• Additional challengesSelecting BusinessesSMEs sometimes get into new businesses becauseof an apparent opportunity without thinkingthrough exactly how they will succeed in thebusiness, or in fact whether it is possible to succeedin the business. The following are steps that can betaken to select businesses in which to compete:• Link to the knowledge and skill set of theSME owner and managersFor SMEs, the advice is to “do what you know.”Since the firm often depends on the knowledgeand skill set of a small number of people, it isimportant to understand what this knowledgeand skill set is and in what businesses they maybe leveraged. Sometimes the knowledge couldbe very narrow and appropriate for only a singleindustry or even a single segment in a singleindustry. In other cases, the knowledge and skillsmay be more broadly applied.• Understand the ease of entryEasy entry in terms of minimal capital costs,licence restrictions, and special qualificationsor approvals may mean that it is easy for theSME to enter, but it also means that otherSMEs can enter as well. The best situation is anindustry that is difficult to enter in general, butin which the SME has particular knowledge,skills, resources, or relationships that make iteasier for the particular firm to enter. The key isunderstanding the potential asymmetries thatmight give the firm an advantage in the newbusiness.• Understand where the firm can be uniqueA good business to enter will be one in whichthere is something distinctive about the firmthat gives it a unique advantage in terms ofcreating value for customers while beating thecompetition. By definition, it is impossible to gainan advantage versus competitors by copying theirstrategies or by having strategies and resourcesthat are easily copied, bypassed, or substituted.Thus firms need to understand or develop uniqueattributes that are hard to copy, bypass, orsubstitute for.

106• Focus on industries where the SME has a“good idea”Some SMEs are founded around a good businessidea that is particularly useful in a particularindustry. The SME should determine what itsgood ideas are and in which industries these ideascan be leveraged. A “good idea” is generally therecognition of a new customer need, a new wayof serving an existing customer need, a distinctivebundling of products or services, or a morecost-effective means of delivering a standardproduct or service. We note that the “goodidea” needs to directly relate to how the SME isgoing to create value for the customer, beat thecompetition, and make money in the process.• Focus on industries where there are unmetmarket needsThe best opportunities generally are found wherethere are unmet market needs that the SME canmeet. It is important to identify exactly whatthese needs are and how the company will meetthem. Unmet market needs provide particularlyvaluable opportunities since meeting them givesthe firm the chance to be a first mover and tobecome established with limited competition, atleast at first.Formulating Compelling Strategies or BusinessPlansMany SMEs do not have a clear strategy. Instead,they jump from opportunity to opportunity. Whilethis may lead to success for a short period oftime, such success rarely persists. There are severalkey steps in formulating compelling strategies orbusiness plans:• Develop a clear visionWithout a clear vision, the company has no cleardirection or reason for being. The vision shouldinclude the purpose of the firm, the scope ofits business, how it wants to position itself, andwhat its core advantages are intended to be.• Identify clear target markets and customersSMEs by definition cannot serve everyone. SMEshave to carefully choose their target marketsand customers. They need to choose who toserve and who not to serve and then tailor theirbusiness plans accordingly.• Identify what customer needs are to be metThe firm must create value for its customersif it is going to succeed. Firms must be veryspecific about the value they wish to create fortheir customers. This is best done by explicitlyidentifying what needs are being met and exactlyhow the firm will meet them in ways that allow itto compete successfully against others.• Determine what the firm can be best inIt is not enough to create value for customers.The firm must develop ways to beat thecompetition in the process. This requires thefirm to determine what it can do better than thecompetition. As one interviewee put it, “The bestnoodle shop in town will make lots of money.”Striving to be the best in important aspects of thebusiness gives the company the best chance forsuccess.• Set clear goals for the companyC l e a r g o a l s p r o v i d e a f o c u s f o r a c t i o nthroughout the firm, a motivator for employeesand management, a means of determiningcompensation, and a means of measuring thefirm’s achievements. Clear goals streamlinemanagement significantly. Without such goals,employees tend to lose track of what thecompany wishes to achieve and fail to come upwith creative ways of operating.

107• Identify the key functional policies necessaryto carry out the strategyOne key to good strategy is internal consistency.All of the functional policies of the firm(production, marketing, financing, administration,etc.) should be consistent with the overallstrategy. SME managers should identify how theirfunctional policies support each other and supportthe vision and goals of the company. If this cannotbe determined, then something in the strategy orits implementation will need to be changed.• Think through different alternatives to getwhere the company needs to goToo often SME managers seize upon theirfirst solution to a problem without thinkingthrough different alternatives before reachinga conclusion. The firm should think throughmultiple options before making major strategicdecisions. Some options may be incremental,some may require stretch, some may be radical.The important thing is not to limit options tooearly before potentially beneficial options areproperly explored.• Identify and arrange the resources necessaryto carry out the strategyToo often SMEs embark on a strategy withoutan adequate sense of the human, financial, andother resources that are required to successfullyimplement the strategy. While detailed resourcerequirement lists may take time to put together,managers are often surprised how quickly theycan come a good estimates of the key resourcesthey require.• Implement the strategyThe best strategy in the world will not be effectiveunless it is implemented properly. This requires aphased approach with clear milestones along theway. It also requires clear communication and asense of shared purpose within the company.• Understand when to change strategyStrategies usually evolve over time. Companiesmust constantly check to see if their strategy issuitable to the external environment and whenchange may be necessary. When a strategy isno longer yielding strong performance, andthere are no improvements in sight, it is time toreconsider the strategy.Understanding CustomersMany SMEs are “order fillers” that act in responseto specific customer orders without understandingthe full requirements of the customer. This makes itdifficult for the SMEs to differentiate themselves orto offer specific services that might enhance theirvalue to customers:• Use the ”order” as starting pointThe firm should think beyond the details of theorder to understand the customer’s business andhow the order fits into it.• Think about new ways to create value forthe customerAn understanding of stated and unstatedcustomer requirements or benefits can providea basis for a longer term and more evenhanded relationship than is the norm. Newways of creating value could include performingadditional functions such as design, managinglogistics and inventories, or other activities• Explore ways of expanding business withexisting customersExisting customers are always the easiest to sellto. Understanding customer requirements is thebest way to explore whether there is a potentialto expand share in the existing product lines,sell to or support the customers in new productlines, or develop business with similar potentialcustomers.

108• Anticipate developments within customercompaniesUnderstanding customers and their requirementsprovides an early warning system for newgenerations of products, new market initiatives,or new technology introductions by customers.Staying ahead of the curve could allow forexpanded business opportunities.• Reassess the attractiveness of customersMany SMEs hang onto unprofitable customersthat drain the SME’s resources and distract themfrom taking advantage of other opportunities.S M E s s h o u l d p e r i o d i c a l l y r e a s s e s s t h eattractiveness of their customers and take stepsto focus on the profitable customers.Understanding competitorsSMEs often do not have the resources to undertakedetailed competitor analysis. Even if this is thecase, it is essential that SMEs understand theircompetitors well enough to be able to developstrategies to beat them in the marketplace:• Learn about competitors from multiplesourcesSMEs should try to learn what they can aboutcompetitors from customers, suppliers, industryexperts, and publicly available informationsources.• Assess the different types of competitorsH o n g K o n g m a n u f a c t u r i n g S M E s f a c ecompetition from firms from the ChineseMainland, Taiwan, Japan, Korea, South Asia,and Southeast Asia, and from other Hong Kongfirms. These different types of firms all havetheir own sets of competitive advantages anddisadvantages.• Reverse engineer competitor strategiesFirms should try to understand the competitors’strategies in some details, particularly withrespect to target markets, advantages anddisadvantages, and intended competitivepositions.• Reverse engineer competitor cost positionsMany Hong Kong SMEs believe their Mainlandcompetitors have a significant cost advantage,but few have actually estimated the magnitudeof this potential advantage and therefore whatactual costs competitors may have.• Track competitor initiatives and buildcompetitor profilesTracking important initiatives by competitorsallows the firm to better understand competitors’strategies, trajectories, strengths, weaknesses,and any creative steps they take. A competitordatabase can be kept to organise information oncompetitors.• Do not underestimate competitorsSMEs often underestimate their competitorsand tend to believe that competitors have unfairadvantages. Competitors are usually smarter thanmost managers give them credit for and whileunfair advantages are often a fact of life that justhas to be dealt with, SME managers all over theworld tend to overstate the unfair advantages oftheir competitors.Developing Clear Competitive AdvantagesSMEs often do not have a strategy to develop clearcompetitive advantages. Beating the competitionrequires the development of clear competitiveadvantages. The key is that the firm needs toidentify, create, and leverage advantages if it isgoing to succeed. These advantages can come fromseveral sources:

109• Superior visionSuperior vision allows the firm to identify andserve opportunities that other competitors maynot realise exist, or to do so in new ways.• Superior knowledgeSuperior knowledge of customer requirements,technological solutions, production processes,distribution channels, sources of supply, andgovernment regulations and policies can all besources of advantage.• Superior resourcesSuperior human resources, financial resources,locations, brands, reputation, and relationshipscan all be important sources of advantage.• Superior capabilitiesSuperior research, design, production, marketing,sales, and administration capabilities can be keysources of advantage.• Combinations of advantagesThe most sustainable advantages are systemicadvantages that result from combinations ofadvantages in vision, knowledge, resources, andcapabilities.Marketing and Selling to Existing and PotentialCustomersMany SMEs have relatively haphazard marketingand sales processes. A better focus on marketingand selling can improve performance in most SMEs:• Focus marketing on firm advantagesMarketing must be based on reality. It shouldfocus on how the SME creates value for itscustomers and on the SME’s advantages versuscompetitors.• Focus on high-value issues of customersCustomers have their own strategies andimperatives (expanding sales, cutting costs, etc.).Marketing should focus on what the SME can doto help the customer carry out its strategy andmeet its imperatives.• Understand the 80/20 ruleFor most SMEs, 80 per cent of sales come from20 per cent of customers. This means the focusshould be on identifying customers that can bepart of the 80 per cent.• Estimate the cost of acquiring and servingparticular customersToo many SMEs chase sales that are expensiveto acquire and retain. Customers that are tooexpensive to acquire and retain should receiveless sales efforts.• Understand the value of “post-salesmarketing”The majority of sales of most SMEs come fromrepeat orders. Following up after deliveryto ensure customer satisfaction and to getinformation on future requirements is a goodway to expand business with new customers.• Use a range of marketing toolsSMEs should not rely on a single marketingtool, but should use a variety of means, suchas word of mouth, trade fairs, advertising intrade publications, cold calls, referrals, and othermeans.• Ensure that payment and credit termsare well understood and due diligence isperformed on customersAgreement on payment and credit termsshould be part of every sale. Due diligence onthe creditworthiness and trustworthiness ofcustomers is also extremely useful to the salesprocess.Financing Operations and FinancialManagementSMEs often have a difficult time obtaining financingfor start-up, expansion, and working capital. Inaddition, many SMEs have rudimentary financialmanagement that can cause problems. Thefollowing are some steps that can be taken toimprove firm finances:

110• Develop strong relationships with banksOutside of family funds and retained earnings,banks are the main source of finance for SMEs.Developing strong banking relations may becritical to receiving bank support in difficulttimes.• Establish credit linesEven though there is an expense to establishingcredit lines, establishing them in advance of needis always preferable to waiting until the needarises when terms may be more difficult.• Consider SME support programmesSME support programmes can be sources ofloans at low rates. SME managers should beaware of these programmes and the potentialbenefits of using them.• Use asset-backed financing when necessarySelling receivables, and borrowing against assetslike land, plant and equipment, and receivablesmay be used as sources of finance.• Institute strong cash management policiesWeak cash management is the most commonreason that SMEs fail. Companies should knowtheir cash position on a daily basis and tightlymonitor cash inflows and tightly manage cashoutflows.• Keep enough cash in the businessIn most cases, the primary source of income forthe SME owner is the profit of the SME. Enoughprofit, however, needs to be retained in thecompany to see it through difficult times.• Institute a minimum balance policySMEs should institute policies that require aminimum cash balance that allows them to meettheir obligations for several months.• Assess creditworthiness of customerscarefullyBefore selling on credit, a careful assessment ofcustomer creditworthiness should be performed.Otherwise cash sales should be considered.• Pursue payment aggressivelyNon-payment by customers can threaten thesurvival of the SME. Strategies for identificationand collection of debts should be in place tominimise the problem.• Take advantage of terms on payablesStretch payables to the extent possible undercontracts and seek early payment discounts tooptimise cash positions.• Understand key financial ratios and reportsand use them as management toolsTrack cash flows, interest coverage ratios,profitability ratios, etc. on an ongoing basis tomonitor performance.• “Stress test” the SME’s financial positionSME managers should “stress test” the firm’sfinancial position by projecting what the cashposition would be if the market had a significantdownturn, if a major customer took theirbusiness elsewhere, if commodity prices suddenlyrise, or if labour rates or other costs were tosuddenly shoot up. The firm should seek toensure that its financial position would be soundeven in the face of such stress.Administering and Managing the FirmMany SMEs have a difficult time administering andmanaging the firm. This is usually due to a shortageof managerial and office support talent coupledwith expanding administration and managementtasks. High priority areas include:• Ensure legal and regulatory complianceKnow the relevant laws and regulations and set upan early warning system to monitor changes in lawsand regulations. Use outside professionals whennecessary to advise on legal and regulatory matters.

111• Implement suitable workplace safetyregulations to minimise on-the-job risksSMEs should ensure that workers are well trainedin the safe use of machinery, and that machineryand vehicles are properly maintained. SMEsalso should ensure that there is a culture thatencourages safety in the workplace.• Provide ongoing training for staff consistentwith the needs of the businessStaff training is crucial across the board.Employees will usually not become moreproductive without some form of training.Investments in training can be seen asinvestments in productivity improvement.• Seek cost–reducing business processesBookkeeping, accounting, payroll, simple ITfunctions, and other processes can often beoutsourced inexpensively. If not, ensure that inhousepersonnel can take on these functions in acost-effective manner.• Develop strong human resources policiesDealing with employees is one of the mostimportant functions of the firm. SMEs shouldattempt to ensure that their HR practices areattractive to workers. In a competitive market,workers who feel that they are well treatedand respected, who are fairly paid, who receiveworkplace training and on-the-job support, andwho can see a future with the company are lesslikely to leave to seek opportunities elsewhere.• Use IT effectivelyComputers and IT systems can be a huge benefitin administering the SME. Ensure that someonein the firm has the necessary skills to use IT tosupport the firm across its administration tasks.SMEs also should have computer security, datacontrol, off-site storage, disaster recovery, anddata location (where they want their data stored)policies.• Set up strong sales proceduresOften SMEs have rather haphazard salesprocedures. The firm should set forth clear salesprocedures that identify how much discretionsales people have in making sales, what creditchecks of customers may be necessary, whatpractices are not acceptable from sales staff,and how sales are to be logged into companyaccounts and systems.• Set up strong purchasing proceduresSMEs should have procedures that governarrangements with suppliers, quotationrequirements, acceptance procedures, andpayment processes. The payment system shouldensure payments are made in a timely manner,against valid invoices, and without overpaymentor duplicate payments.• Set up strong monitoring and controlfunctionsSMEs often do not have strong monitoringand control functions. As a result, they oftenrecognise problems only when it is too late.Inventory control, cash control, fraud prevention,risk management, and internal reportingprocedures are all crucial to firm success.Keeping Up To Date on Market, Technological,and Managerial DevelopmentsMany SME owners and managers are so busymanaging their companies that they do not keep upto date on market, technological, and managementdevelopments. Doing so is crucial for companiesto be able to compete effectively. SMEs cannotafford to lose customers to their competitors onthe basis of slow response times or lack of currentknowledge. Steps that can be taken include:• Keep up to date on market developmentsMeetings with customers and potentialcustomers, the general business press, tradepublications, and active participation in industryassociations can aid in this area. The Hong KongTrade Development Council also provides periodicmarket updates for major markets and industries.

112• Keep up to date on technologicaldevelopmentsCustomers, trade press, industry associations,consultants, and organisations like the HongKong Productivity Council are potential sourcesof information on technological developments.• Keep up to date on managementdevelopmentsIndustry associations, chambers of commerce,business schools, and organisations like theHong Kong Management Association arepotential sources of information on managementdevelopments relevant to SMEs.Reducing Dependence on Individual Customersand SuppliersMany SMEs rely on individual customers for adisproportionate part of their business. Whilethis is natural in a start-up, overreliance on asingle customer puts the SME at the mercy ofthat customer and makes any downturns in thatcustomer’s business difficult to deal with. ManySMEs also rely on a small number of suppliers dothat disruption of inputs from a single supplier cancreate enormous difficulties:• Diversify customer baseCompanies cannot rest once they get a singlecustomer, even if that customer takes up theexisting capacity of the SME. It is usually advisableto continue to search for new customers todiversify risk and reduce bargaining power of thesingle customer.• Seek guaranteesIf a customer demands exclusivity, then the SMEshould seek financial guarantees to offset theassociated risks.• Identify multiple suppliersEven if the SME’s present suppliers aresatisfactory, additional suppliers should beidentified for overflow capacity, to keep pressureon existing suppliers, and to step in case ofsupply disruption.Additional ChallengesThere are several other challenges that SMEsface. Approaches to dealing with some of thesechallenges include:• Enhance firm reputation and goodwillA reputation for reliability, high productstandards, fair dealing, and willingness to beflexible when necessary can be a key competitiveadvantage for the firm. Avoiding situations thatmight damage reputation and goodwill is alsocrucial.• Seek outside advice when necessaryWhile professional services may be expensive,SMEs need to be able to call on lawyers,accountants, consultants, IT specialists, andothers when necessary.• Manage government relations carefullyGovernment relations are particularly importantin the Chinese Mainland. SME owners andmanagers operating in China should find waysof interacting with officials on a regular basis tobuild up dialogue and understanding.• Develop long-term relations with keycustomers and suppliersLong-term relationships allow for betterunderstanding and the potential for developingtrue partnerships with selected customers andsuppliers.• Do forward-looking risk analysisSME managers often claim to be too busy to doproper risk analysis. However, SME managersneed to determine what could go wrong in theexternal and internal environments and preparefor the potential for such events to occur. Riskassessment should focus on the likelihood andpotential magnitude of disruption caused byrisk events. Contingency plans then should bemade for the most important risks. Ongoing riskassessment and contingency planning is often thedifference between survival and death for SMEs.

113• Plan for successionSuccession planning can be difficult for SMEs,particularly if the founder has no relative readyand willing to take on the task. It is best tothink about succession planning early, to groompotential successors, to consider turning overmanagement to professional managers if there isno ready successor, or to identify potential buyersif the owner-operator wishes to sell out.Questions that Hong Kong SMEsmust AnswerThe list of potential strategies may seem daunting,but it all comes down to being able to ask andanswer a number of basic questions about thefirm’s strategy, its customers, its competitors, andhow the firm’s strategy should address customersand competition. These questions can be usedto prioritise the firm’s information gathering andstrategy setting process.The challenges and strategies available to HongKong manufacturing SMEs lead to many questionsthat the SMEs need to be able to answer abouttheir business:• Which strategy or strategies will the SME use todeal with cost pressures?• Which strategy or strategies will the SME use todifferentiate itself to gain some pricing flexibility?• Which strategy or strategies will the SME use todeal with labour market pressures?• Which strategy or strategies will the SME use forits business model development?• Which geographic markets will the SME focuson?• Which strategy or strategies will the SME use todeal with regulatory and policy-related issues?• If exit or consolidation strategies are appropriate,which strategy or strategies will the SME use?In order to answer these questions, the SME willhave to answer several other questions about theirbusiness and business environment. These include:• What is competitive balance among Hong Kongfirms, between Hong Kong and Chinese firms,between Hong Kong and foreign firms operatingin China, and between Hong Kong firmsoperating in PRD and firms operating in otherlocations?• What are the sources of advantage anddisadvantage for each type of firm? What are thespecific sources of advantage and disadvantagefor the individual SME?• What is the specific cost structure of theirown business in the PRD (or wherever they arelocated) versus other places today, and how isthe comparison evolving?• Does the sector in which the SME competeshave a future in Southern China, or should newlocations by sought urgently?• What are the customer segments that areavailable to the firm and what are the customerrequirements in the different segments?• For companies operating in the ChineseMainland, how is their sector perceived by theMunicipal, Provincial, and Central Governments?Does it get favourable, unfavourable, or neutralattention?• To what extent are environmental or productsafety regulations important in the sector?• What new business models or activities might beopen to the firm?• Which of the external issues is most pressing fortheir business?• Does the firm have a clear strategy targetingspecific types of customers, with plans to satisfytheir needs, with specific competitive advantages,and with the resources necessary to carry out thestrategy?• Does the firm have a clear view of what it canand will do better than competitors?• Does the firm have the managerial, administrative,and operational capability to carry out the strategyeffectively? If not, how can these capabilities beobtained?• Does the firm have sound financial, marketingand sales, administrative, control, and riskmanagement processes in place?

114• Who will manage the firm into the future?• When might it be necessary or beneficial to engagein collective action with respect to supplychain development, relocation, or other issues?It will be very difficult for Hong Kong’s manufacturingSMEs to survive and thrive if they do not have goodanswers to these questions. On the other hand,developing good answers to these questions is thefirst step in facing and meeting the challenges thatconfront Hong Kong’s manufacturing SMEs.Potential for Collective ActionThe strategic options listed above focus for the mostpart on what the individual firm could or shoulddo. However, there are some responses to strategicchallenges that may be appropriate for collectiveaction. While SMEs often find ways of collaboratingin terms of lobbying efforts and the general provisionof information and management training, it is far lesscommon to find SMEs collaborating on operationalbusiness matters. The list below is a partial list of thesorts of collective action that SMEs may engage into overcome the disadvantages of small scale. Someof the items focus on dealing with external issues,others focus on trying to obtain the benefits of scalethrough collective action. They include:• Investments in effluent control that areeffective only in large scale. Some industries,like electroplating, semiconductor production,leather tanning, fabric dyeing, and others areby their nature polluting. In some cases, thereare means of handling the effluent that are onlytechnologically effective or cost-effective if theyoperate at relatively large scale. By definition,such investments or scale will be beyond themeans of individual SMEs. However, SMEsbanding together to either invest in appropriatetechnologies, or relocating to the same place tothe investment can be made, may bring thesetechnologies into play. In Spain, for example, agroup of leather producer SMEs cooperated toset up a third party firm to handle the effluentfrom the tanning process for all of them. A groupof Hong Kong electroplating companies havebeen negotiating to relocate to a single industrialpark in Guangdong.• Relocation of production chains. Relocation dueto high costs can be difficult for individual SMEsbecause if they move on their own they mayseparate themselves from their supply chain. Onthe other hand, if a sufficient number of firmsrelocate to the same location, they may provideenough of a critical mass to pull the supply chainwith them. In Northern Italy, a group of footwearmanufacturers decided to all set up production inthe same town in Romania. This induced enoughof the supply chain to follow to make the moveviable. A few years ago, 11 Chinese mobilephone manufacturers all moved in concert toHuizhou. They were able to negotiate with themunicipal government for facilities and eventhe establishment of a mobile communicationsresearch centre to support their activities.• Bulk purchasing. SMEs often cannot purchaseinputs and materials at the same prices of largerfirms with higher volumes. This disadvantage canpotentially be overcome through coordinatedbulk purchasing. There are many examples ofthis worldwide with groups of firms coordinatingto purchase, raw materials, components,warehouse space, transportation services, marketintelligence, consulting services, accounting andpayroll services, and other business requirements.• Full line provision. Some customers, particularlylarge retailers or OEM customers, may desire topurchase a full line of products from a singlesource. Normally SMEs cannot hope to supplysuch customers. However, in some cases it maybe possible for SMEs to join forces to supply thefull line that the customer desires. This requiresa unified approach and clear division of labouramong the SMEs.

115• Joint or place branding and promotion. Manyproducts and services around the world areknown to come from a particular location. Scotchwhisky, champagne, and burgundy are madeby several companies from particular areas. InHong Kong, numerous players in the tourismsector support joint branding and promotionof Hong Kong as a tourism destination. ManySMEs participate in Hong Kong’s trade fairs, ina sense cooperating to provide a wide range ofsellers to attract the highest number of buyers,but then competing in the fair itself to sell theirown products. In the process, Hong Kong getsa reputation as the “place to be” to purchase inparticular industries.There are several obstacles to collective action ofthe types mentioned above. First, someone has toidentify the potential for collective action, whichmay be difficult if individual SMEs each have onlypart of the relevant picture. Second, someone hasto investigate whether the potential collaborativeaction is viable. Third, SMEs usually do not haveforums in which they can discuss and negotiate thedetails of collective action. Fourth, SMEs usuallyneed a neutral party to facilitate discussions andplans for collective action. Fifth, if the collectiveaction requires government approval or permissionof some sort, the SMEs usually find it hard toorganise who will negotiate on the part of thegroup.Overcoming the obstacles to collective action canoften only be accomplished by industry associationsor more general associations of companies.Such groups are often the only ones in positionto understand the immediate challenges andopportunities their members face and to act as acatalyst to bring firms together to explore, develop,and implement collective strategies. This couldbecome an ongoing role for the Federation of HongKong Industries, which already engages in someactivities of this sort.

116ConclusionsHong Kong manufacturing SMEs face manyissues going forward. These include uncertainglobal markets, rising costs in their traditionalproduction locations, changes in legal andregulatory environments, an increasingly difficultcompetitive environment, Chinese MainlandPolicies affecting operations in the Mainland, anda host of operational and strategic issues. All ofthe issues identified above are significant in and ofthemselves, but they must also be put into properperspective and context in order to understandwhat the future may hold.Perspectives on Key IssuesThe global economy has been experiencing adownturn, but the global economic environmenthas actually been quite good for most of the last30 years. The RMB is under pressure to appreciate,but the consensus among economists everywhereexcept the Chinese Mainland has been that it hasbeen severely undervalued for a long time. Labourcosts are rising in the Chinese Mainland, but forwell over a decade previously they were virtuallyunchanged in real terms. Utility costs are rising inChina, but some utility prices, like electricity arestill well below global norms. Legal and regulatorychanges in China are affecting Hong Kong SMEsoperating in the Mainland, but the Chinese legaland regulatory system allowed them to set upand operate in the first place. The competitiveenvironment is becoming tougher, but it was theinitial lack of Mainland companies with knowledgeof processes, products, and markets that allowedmany Hong Kong companies to become establishedin the first place. Chinese policies about industrialdevelopment are affecting SME operations in theMainland, but again Chinese development policiesallowed the Hong Kong firms to set up as well.SMEs by their nature face strategic and operationalissues, but successful SMEs find ways to overcomethese issues.Some interviewees expressed a view that HongKong manufacturing companies, particularly SMEs,became established through a particular set ofcircumstances that may indeed change forever. Ifso, then many Hong Kong manufacturing SMEswill face difficult times. However, with changealso comes opportunity. It will be the ability andwillingness of the Hong Kong companies to changeand to exploit existing and new opportunities thatwill determine their future.Looking BackHong Kong industry has evolved enormously overthe last few decades. Thirty years ago, few wouldhave imagined the important role that Hong Kongindustrial corporations would play in today’s globaleconomy. Fewer still would have imagined thatthe key to this importance would not be artificiallytrying to keep industrial activities within HongKong, but rather it would be adjusting to changingcircumstances and pioneering new productionlocations outside of Hong Kong. This is just oneexample of the constant reinventing of Hong Kongindustry that has occurred over the period.Looking back, the success of Hong Kong industryhas depended on its ability to take advantage ofopportunities resulting from major developmentsin the global economy, such as reduction of tradebarriers, increasing affluence in global markets,improvements in transportation and communicationtechnology, containerisation, the emergence ofmodern supply chains, the separation of productionfrom other corporate activities, and the reintegrationof the Chinese Mainland into the worldeconomy. Similarly, looking forward, the successof Hong Kong industry will depend on its abilityto take advantage of opportunities resulting fromfuture developments in the global economy. Ittherefore makes sense to project what some ofthese developments might be.

117New OpportunitiesOne major development going forward will be therise of consumer markets in the Chinese Mainland.By the middle of this century, the Chinese Mainlandwill have the world’s largest economy by asignificant margin. According to some estimates,Chinese consumer demand accounts for around sixper cent of global consumer demand today, but isexpected to rise to over 25 per cent by 2025, andits share will continue to grow thereafter. Whatwill be the world’s largest market is right on HongKong’s doorstep, and it will be a market in whichHong Kong companies have had production andother activities since the 1980s. Yes, there will beintense competition in the China market, fromChinese companies and from companies from allover the world, but the China market still will offerenormous opportunities for Hong Kong industry,and some Hong Kong companies will undoubtedlygrow large serving something they have never hadbefore, a huge domestic market.By the middle of the century, the Chinese Mainlandwill also be by far the world’s leading industrialcountry. The industrial sectors in the OECDcountries are diminishing in relative importance andeven though costs will rise in China and resourceswill become somewhat constrained, there is simplyno other country, or even set of countries, thatwill have the population, the infrastructure, andthe international supply chains necessary to keepup with China. Southeast Asian countries are toosmall and will saturate before they become truecompetitors to China. India will have decades worthof infrastructure to construct, educational policiesto develop, and regional geo-political problemsto resolve. Africa is too fragmented and lags toofar behind. The world’s largest industrial economywill be right on Hong Kong’s doorstep, but it willnot be the same industrial economy we see today.Instead, as cost pressures mount on the coast andinfrastructure improves in the interior, we will seea much more geographically balanced productionprofile around China and companies managing anindustrial portfolio in China will need to manage inmore than a single location.Another major development will be closer economicintegration between Hong Kong and the ChineseMainland. By the middle of the century, HongKong and the Mainland may have decided that“one-country, two-systems” has been so useful toboth sides that it should be retained in some formor another even beyond 2047. Certainly, DengXiaoping once stated that such might be the case.No matter what the exact circumstances of thepolitical situation at the time, in economic termsthere is likely to be complete or nearly completeintegration by the middle of the century. Theintegration will be facilitated by arrangements suchas CEPA, the Hong Kong-Guangdong FrameworkAgreement, and their successors. It will also befacilitated by infrastructure such as the Hong Kong-Zhuhai-Macao Bridge and the linking of HongKong with the national high speed rail network.Closer economic integration with the ChineseMainland means that Hong Kong industry is likelyto be far more diverse than it is today, as HongKong will be a prime location for headquarters,management, finance, marketing, sales, corporatecommunications, design, research, and logistics,not just for traditional Hong Kong companies, butfor companies originating in the Chinese Mainland,elsewhere in Asia, and elsewhere in the world. Thediversity will be reflected not only in the locationof origin of companies that will either move toHong Kong or carry out important functions inHong Kong, but also in the industrial mix as thefull industrial diversity that will be present inSouth China will be reflected by companies with apresence in Hong Kong as well.A n o t h e r m a j o r d e v e l o p m e n t w i l l b e t h einternationalisation of companies from the ChineseMainland. Today, China’s outbound investment isdwarfed by its inbound investment. By the middle ofthe century, in all likelihood this situation will havebeen reversed, or at least the investment flows willbe far larger and better balanced. Despite commonbelief, the vast majority of China’s outboundinvestment to date has not been in the resourcesector, but in the service sector. This investment willset the stage for much larger outbound investments

118by Chinese industrial enterprises in the future. It isquite likely that several of these outward industrialinvestors will run their international operations, ormake their international investments, from HongKong-listed and / or domiciled subsidiaries, and itis quite probable that some will even place theircorporate headquarters in Hong Kong.Rising affluence in China and India, as well asin the rest of the developing world, will result incomplex segment structures across a wide rangeof industries. While more affluent countries andsegments within developing countries will seegreater fragmentation and specialisation in demandand supply, at the same time hundreds of millionsof developing country consumers will create massmarkets of unprecedented size. The result will bethat there will be a wide range of strategies, coststructures, and production locations that will beable to succeed, even within a single industry. Thiswill make identifying, understanding, and servingspecific customer niches even more important, andpotentially even more valuable, in the future thanthey are today.New PressuresThere will be pressures on Hong Kong industry aswell as opportunity. Costs will continue to rise inthe traditional production locations of Hong Kongfirms. Chinese officials will continue to work torestructure the economy of the Pearl River Delta.Mainland companies will rise to compete directlyagainst Hong Kong companies in more and moreindustries. Foreign buyers and retail chains willcontinue to exert tremendous pressure on theirsuppliers to reduce prices while improving qualityand expanding service levels. In addition, we canexpect that over the next several years resourceconstraints and environmental considerations willcontinue to grow in importance. The rise of Chinaand India imply resource demands that will strainglobal supplies. Companies will have to developproducts and processes that use resources moreefficiently. Under all these pressures, we wouldexpect to see some industries in which HongKong companies compete to consolidate, othersto be transformed, and some to diminish or evendisappear. And even in those that remain, successand even survival might be difficult to achieve forindividual companies.But while many existing companies will comeunder pressure, the overall picture remains one ofopportunity for Hong Kong industry: opportunityto serve the world’s fastest growing consumermarkets, opportunity to participate in the world’slargest industrial base, opportunity to takeadvantage of closer interaction with the ChineseMainland, opportunity to benefit from the influx ofcorporations into Hong Kong, and opportunity toride the wave of increasing specialisation. This is notto say that opportunity will automatically lead tobusiness success. In fact, in order to take advantageof the opportunities it will be necessary for HongKong industry to reinvent itself one again.The Need for ReinventionThis reinvention will involve a clear understandingof economic, business, and policy trends. It willinvolve developing the skill sets to develop, design,produce, and sell products that can meet markettests in China, the rest of Asia, and elsewhere. Itwill involve developing the capabilities to manageoperations in Hong Kong, in South China, inthe rest of China, and elsewhere. It will involvemastering modern communication and informationtechnologies as research, management, andmarketing tools. It will involve moving beyond thelimited set of industries in which Hong Kong wasonce a leading production location to embracethe entire range of industrial possibilities affordedby access to China. It will involve learning how toserve rapidly emerging niches is rapidly emergingmarkets. It will involve taking on more activitiesthan the simple OEM “order taking” pattern ofmuch of Hong Kong’s traditional companies. It willinvolve developing compelling business strategiesthat identify specific unmet needs and tailor abusiness proposition to meet those needs. It willinvolve higher levels of professionalism in internal

119management, especially when it comes to finance,human resources, and government relations. Itmay also involve more creative use of collaborativestrategies among Hong Kong SMEs than hasgenerally been the case in the past.We note that success for Hong Kong industry willtake on a variety of forms. In some cases, it will betraditional Hong Kong companies that succeed; inother cases it will be brand new companies foundedby Hong Kong people that will succeed; in stillother cases it will be companies founded in HongKong or moved to Hong Kong by entrepreneursthat originally came from elsewhere that willsucceed. Perhaps the most important characteristicof Hong Kong industry in the past has been theability to recognise new opportunities and todevelop business out of opportunity. It is this samecharacteristic that will determine the performanceof Hong Kong industry in the future.The Present ReportThe present report indicates that even in the faceof challenges, that there are some sectors in whichHong Kong firms and Chinese production are likelyto continue to be very competitive. There appear tobe no viable alternatives to Switzerland and Chinaas production locations in the watch sector, andHong Kong firms continue to have strong positions.China’s position in the toy sector is so strong that itis unlikely other nations will make strong inroads inthe near term and the position of Hong Kong firmsremains strong. Hong Kong firms are coming underincreasing pressure in the mould and die industry,though in a context in which China is easily theworld’s largest growth market. While there isincreasing pressure in the low end of the garmentindustry from South Asia and other locations, Chinais expected to be the dominant player well into thefuture, and Hong Kong companies remain wellpositioned.In electronics, China as a whole hasbeen expanding its position, and Hong Kong firmscontinue to find interesting niches. None of thismeans success for Hong Kong firms is guaranteed.In fact each of these sectors is gong to get moredifficult for Hong Kong firms. However, theindividual case studies show specific examples ofstrategies that Hong Kong companies have usedto continue to succeed in the midst of difficulteconomic and business circumstances.In addition to providing some specific examples,the report aims to set out the strategic optionsthat Hong Kong SMEs have in order to meet thechallenges and take advantage of the opportunitiesthey face. We note that there is no single recipeor path to success, but rather several potentialrecipes or paths to success. The industry situationreports and case studies should make this clear.The right strategy for an individual SME will dependon its sector, the segment it chooses to address,the nature of customers and competitors in thesegment, and its own skills and capabilities, Insteadof trying to provide a single recipe, we have triedto set forth in a comprehensive manner the optionsthat are potentially available to Hong Kong firmsand the strategic and managerial principles they willneed to successfully formulate and implement theirstrategies. This report and the accompanying “SMEAdvisory Kit” should be viewed as guides and toolsto aid them in this process.1 The minimum wage for Huadu, Panyu, Nansha, Conghua,and Zengcheng Districts of Guangzhou as of mid-2010 wereRMB 960 per month for full-time employees and RMB 5.52per hour for part-time employees. www.gzlss.gov.cn.2 The Zhuhai Municipal Government has set the minimumwage for full-time employees at RMB 960 per month andthe minimum wage for part-time employees at RMB 9.2,per hour, higher than that mandated by the GuangdongProvincial Government. www.zhldj.gov.cn. www.gd.lss.gov.cn.3 On 27 May 2010, the State Council approved the expansionof the Shenzhen Special Economic Zone to the wholecity. Therefore, Bao’an and Longgang districts have beenincluded in the Special Economic Zone since 1 July 2010.

120AcknowledgementThe Federation of Hong Kong Industries would like to thank the Steering Committee of the Study for theirinput and guidance during the course of the project, Professor Michael Enright and his team from Enright,Scott & Associates Ltd. for their assiduity and professionalism in conducting the research work, and the coordinatingteam for their hard work and dedication to the project.Wholehearted gratitude is also extended to the many manufacturers and companies who participated in theinterviews and case studies. The information they provided has been crucial to the success of the Study.Finally, if not for the generous support of the SME Development Fund and 19 sponsor organisations, theStudy would not have been possible. The FHKI is very appreciative of their commitment and support.Steering CommitteeCliff Sun, BBS, JPExecutive DirectorKinox Enterprises LtdStanley Lau, BBS, JPManaging DirectorRenley Watch GroupDavid WongChairmanDah Sing Bank LtdVictor Lo, GBS, JPChairman & Chief ExecutiveGold Peak Industries (Holdings) LtdWilly Lin, SBS, JPManaging DirectorMilo’s Knitwear (International) LtdStanley YimChairmanHong Kong Trade Services CouncilHon Andrew Leung, GBS, SBS, JPChairmanSun Hing Knitting Factory LtdJimmy Kwok, MH, JPManaging DirectorRambo Chemicals (Hong Kong) LtdMichael YuDirectorSunnex Products LtdKenneth Ting, SBS, JPChairmanKader Industrial Co LtdClement Chen, BBS, JPExecutive DirectorTai Hing Cotton Mill LtdBernie TingDirector/General ManagerQualidux Industrial Co LtdDr C H NgChairman & Managing DirectorSuga International Holdings LtdJimi KwokDirectorGolden Sun Housewares ManufacturingLtdDr Roy Chung, JPGroup Vice-chairman & Executive DirectorTechtronic Industries Co LtdTo Wai-hungChairmanHong Kong Mould & Die CouncilSponsorsDah Sing Bank LtdDunwell Enviro-Tech (Holdings) LtdGold Peak Industries (Holdings) LtdHong Kong Mould & Die CouncilKader Industrial Co LtdKinox Enterprises LtdLee Kum Kee Co LtdMilo’s Knitwear (International) LtdQualidux Industrial Co LtdRambo Chemicals (Hong Kong) LtdRenley Watch Manufacturing Co LtdSuga International Holdings LtdSun Hing Knitting Factory LtdTai Hing Cotton Mill LtdTechtronic Industries Co LtdHong Kong Trade Services CouncilOn Hing Paper Holdings LtdSunnex Products LtdGolden Sun HousewaresManufacturing LtdFHKI Co-ordinating TeamDennis Yau Alexandra Poon Roger Tam Jeffreys Tsang Peter Leung Claire Li Carmen Chiu

Federation of Hong Kong Industries31/F, Billion Plaza, 8 Cheung Yue StreetCheung Sha Wan, Kowloon, Hong KongTel : (852) 2732 3188Fax : (852) 2721 3494Website : www.industryhk.orgEmail : fhki@fhki.org.hk