Rising costs destroy profit margins in Wenzhou, firms shift to real estate

Wenzhou, Zhejiang is one of the most wealthy parts of China. It was one of the first areas to latch on to the opening of China and it's home to hundreds of businesses. Here is a snip from the Wiki entry:
In the early days of economic reforms, the people of Wenzhou took the lead in developing a commodity economy, household industries and specialized markets. Many thousands of people and families were engaged in household manufacturing to develop individual and private economy. Up till now, Wenzhou has a total of 240,000 individually-owned commercial and industrial units and 130,000 private enterprises of which 180 are group companies, 4 among China’s top 500 enterprises and 36 among national 500 top private enterprises. The quantity, industrial output, tax, export and number of employees of the private enterprises account for 99%, 96%, 75%, 95% and 80% of the whole city respectively. There are 27 national production bases such as “China’s Shoes Capital” and “China’s Capital of Electrical Equipment”, China’s 40 famous trademarks and China’s famous-brand products and 67 national inspection-exempt products in the city. The development of private economy in Wenzhou has created the “Wenzhou Economic Model”, which inspires the modernization drive in China.

The city of Wenzhou is a world leader in lighter manufacturing with over 500 such companies in the city.[3]

There are many area in which people of Wenzhou open the first example of private economy. For instance, Junyao Airlines is built on July, 1991, which is the first and still the only private airline company in China. Jinwen Rail Way is also the first rail way company which is built with private capital.

However, 2010 was worse than 2008 for many of these businesses. (And as you'll read below, the wiki needs updating on the number of lighter companies.) The Economic Observer has a front page story on Wenzhou this weekend:


"Private companies in Wenzhou did not make any money in 2010"

Here are some of the reasons why. (What follows is not a translation. I have mixed my own comments in with some rough translations of portions of the article.)

A sofa manufacturer saw cotton materials go from 450 RMB to 670, then down to 550 RMB, still a 20% increase. Even though his sofa sales increased two to three times, the manufacturer ate the costs and his profit was gone.

Wenzhou's garment industry saw revenues up about 30% and exports up 20%, but profits were meager.


In Wenzhou, the "Shoe Capital of China", one executive says a factory there already closed 4 of 14 production lines due to a shortage of workers. Wages have gone from 1200 RMB/month to 1500-1800 RMB/month, yet they still cannot find workers. Note that he says "already," as he doesn't expect this trend to end. He goes on to estimate the labor shortage at 10-20%, industrial rents went up 5% in 2010 and material costs rose 20%. Profits are barely 2-3%, down from 8%.

In the lighter business, the number of firms has plunged from 500 pre-crisis to 80, but the soaring business at the remaining firms is being eaten up by rising copper and zinc prices. One firm says they're breaking even, but staying in operation to maintain stability and provide employment for the workers.

The glasses industry points to three culprits. Wages have doubled since 2008, to about 1800 RMB/ month. Raw material costs are up 20%, and the currency fluctuations in the U.S. dollar and euro are impacting exports.

Companies in Wenzhou also complain about the corporate tax burden. Tax officials asked some businesses to prepay one year of taxes! An industrial association official said he believes China's tax burden exceeds that of developed nations, he believes it is actually the greatest in the world.

Between the second and third quarter (recall that commodities really started hopping in Q3), only one-third of businesses in Wenzhou reported an increase in profits.
"It is difficult to raise prices, the firm has no choice but to bear the rising cost pressure." So says Wu Jianhai, who created the China Mall in Cameroon. His retail profits are up, but still far from the level they were at before the financial crisis. He says the cost pressures are so great that profits from trade are not even one-tenth of the level in 2000.

The article goes on to discuss how companies are dealing with current conditions. Some firms are exiting, some consolidating, and also upgrading of plant and equipment. The outlook isn't completely negative, as the weak firms exit and business stabilizes for the remaining firms. Some are also exiting to other sectors, such as solar and biotech.

However, many businesses aren't going this route. Instead, they are getting into real estate development (the large firms) and flipping properties (the small firms). Of Wenzhou's top 100 companies, 2 are real estate companies and 6 are construction companies, but 40 others have gotten into the property business. These manufacturing firms borrow money to finance their real estate operations and seven of these real estate development divisions each have more than 3 billion RMB in capital (roughly $500 million).
Of course this has affected land prices. From May to August of last year, the average transaction price was 28,000 RMB/square meter, the highest in the country. In November, one housing development saw prices of 37,000 RMB/sq. meter.
Consequently, a clear cycle has emerged: manufacturing becomes difficult, so they shift capital into real estate, real estate prices rise, costs rise, and manufacturing really becomes difficult.

This move into real estate fits with a story from last year. In July 2010, I blogged about Wenzhou Private Interest Rates Hit 96%. It was about the speculation taking place in the city. Obviously, the bubble didn't burst and prices have continued moving higher.

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