Bankruptcies create cracks in global supply chain

HONG KONG - China’s hopes for a speedy export recovery from the global crisis could be undermined by the weakest links in its powerful supply chain - smaller firms too damaged by the downturn and credit crisis to get goods to market.

As collapsing sales to recession-hit Western markets weigh on China’s economy, bankruptcies pose a growing risk to its export machine, threatening everyone from suppliers of key parts and materials to firms which transport finished products.

Struggling Chinese exporters are facing higher costs as they need to keep closer checks on suppliers, and a shrinking pool of financially healthy companies to deal with is limiting their vaunted flexibility, slowing down delivery times.

“The financial crisis is creating a situation that is unparalleled. If a Chinese company cannot sell to a Hong Kong company, which in turn cannot sell to, say, a foreign department store, each of their businesses will be effected,� said Satpal Gobindpuri, a partner in Hong Kong at lawyers DLA.

“It’s creating a domino effect. Anyone with half an ounce of business acumen should be looking at their supply chain ... They might need suppliers in reserve or be looking to assist their major suppliers.�

PricewaterhouseCoopers estimates 670,000 small firms have already closed across China in the wake of the global crisis.

In addition to tumbling exports, firms have been hit by a squeeze in credit markets. Some 90 percent of world merchandise trade is funded by trade finance, such as letters of credit.

China’s potential vulnerability to any breaks in its supply chain was highlighted by a report on Wednesday showing factory output and new orders returned to mild growth in February after shrinking for four months, though analysts cautioned about reading too much into the rise.

Hong Kong’s Wing Fung Optical International Ltd, which makes sunglasses and eyeglass frames in the southern Chinese city of Shenzhen, has seen sales skid 25 percent in recent months as demand shrinks in its key markets, Italy and the United States.

But director of business development Raymond Chan says recent bankruptcies among its suppliers pose a bigger risk to the firm.

When a parts supplier went bust recently, sending Wing Fung scrambling to find an alternative source that could offer the same quality, delivery on a U.S. order was held up by two weeks -- a delay that could have cost Wing Fung its customer.

“Delivering on time is crucial if we want to stay competitive,� said Chan.

Adding to the problem is that many small businessmen in China are reportedly running away without legally winding up their companies, often just posting a notice on the factory door. Customers are left in the lurch with no chance of getting back any money owed or receiving goods they have ordered.

“They see no point in winding up operations properly if they don’t have assets to pay creditors and workers,� Gobindpuri said.

Alarm bells

Risk consulting company Kroll Inc says it has seen a surge in demand asking for checks on Chinese suppliers. Red flags include workers not being paid on time or being laid off, delays in delivery times, or a sudden shift to a new business.

“If a supplier is moving into another area of business, they’re doing it for a reason,� said Jack Clode, Kroll’s managing director of business intelligence and investigations. �It also means the (existing) customer may no longer be a priority.�

Clode, who foresees a sharp increase in factory closures in China this year by mid-sized Western companies as their domestic demand evaporates, says financial strains are also prompting suppliers to cut corners with cheaper materials.

Wing Fung has cut its number of suppliers by a quarter in recent months, dropping those which are late paying their bills. It also says it is extending credit to long-standing, reliable suppliers who are having short-term financial difficulties.

Chinese manufacturers are also growing worried about the health of their customers in the West as those economies worsen.

For the first time, Kroll is being asked by Chinese firms to conduct due diligence on Western customers.

“Li & Fung set off alarm bells,� said Clode, referring to the Hong Kong blue-chip global supply chain manager.

Li & Fung sources goods for Wal-Mart Stores Inc among others, and is the biggest creditor of former leading U.S. toy retailer KB Toys Inc.

When KB Toys filed for Chapter 11 bankruptcy protection in December, Li & Fung was owed $5 million.

Wing Fung was also caught last year when an Italian wholesaler suddenly went out of business. The Hong Kong firm is still awaiting payment for goods, but does expect to be paid eventually, which is not the case with its bankrupt Chinese suppliers.

Strong longer-term prospects

While rising bankruptcies are raising the risk of doing business in China, it is unlikely to lose its status as a low-priced global trade centre, not least because many firms are targeting the country’s huge domestic market in the long run.

A survey of multinational firms in China released this week by U.S.-based management consultants Booz & Co showed 90 percent of 108 respondents said they had no plans to relocate from China, up from 83 percent in a similar survey a year ago. Executives cited China’s domestic market as the main reason for staying put.

Chip maker Intel Corp recently announced it would close plants in Malaysia and the Philippines but would stay in China, relocating from Shanghai to Dalian in the northeast and Chengdu in the west, where land and labour costs are lower.

Wing Fung has also considered shifting within China rather than leaving.

“Everything is available in China, all the parts,� said Chan.