Tuesday, September 13, 2005

The Chinese Pencil Industry & World Reaction: Part 1

The third in a continuing series of posts on international trade issues affecting the pencil industry.

My earlier posts focusing on pencil Anti-dumping duties provided first, a primer on the purpose and structure of such duties, and next an update on current developments on US anti-dumping duties against Chinese pencils. Anti-dumping duties in the world wide pencil industry are singularly focused on Chinese pencils.

As we’ve seen in order to protect their domestic manufacturing industries from what is perceived as unreasonably low priced and perhaps as unfair competition from China many countries have implemented dumping duties. My own experience is that many producers in the Chinese pencil industry don’t always seem to understand or agree with the justification for such anti-China trade polices. I have spoken with key Chinese managers who reflect a shared point of view that the Chinese pencil industry is not very important in the world picture. They complain that the growing number of small pencil producers who compete only on price, make the Chinese industry as a whole unprofitable in their domestic market.

As a result many Chinese producers look to the export market for higher value added opportunities. However they themselves don’t always feel they get a fair chance to compete with the world’s major brands. They complain they are expected to offer a significant price advantage to branded producers elsewhere in the world. They are left only with lower value OEM sales to existing brands or private label opportunities to foreign retailers for market entry. Some hold the view that to overcome the high import duties on their pencils they must hold their prices down to negligible levels. Thus further perpetuating demands for anti-dumping duties on Chinese pencils by producers in foreign markets.

In response to these pressures a small minority even resort to illegal practices such as counterfeiting western brands in the Chinese home or other third world markets. Some even purposely mislabel country of origin and transship via third countries to avoid these duties. None of these activities reflect positively on the Chinese industry as a whole since it’s often difficult to establish who the manufacturer is when they are producing private label products.

So when both Chinese and foreign pencil manufacturers often cry foul, where does the truth lie. As usual it’s somewhere in the middle.

The Chinese pencil industry currently produces 9.8 trillion pencils per year based upon the 2004 statistical data. Of these pencils about 80% are exported throughout the world with the US being the single largest market and the EU second. By our industry estimates Chinese pencils now represent over 50% of the world’s pencils on a volume basis. So it’s clear that the Chinese Industry is no small, unimportant player when it comes to pencils.

What of Chinese complaints about low price expectations of foreign buyers? It’s true Chinese pencils are on average the lowest priced pencils in the world as is their cost structure. This is why large distributors and retailers like Walmart, Target and others have set up their own purchasing offices in China to play one producer off against the other during their annual purchasing programs. Often Chinese export prices realize just one-fifth of the retail prices ultimately paid by consumers. What Chinese producers fail to realize however is that such practices still provide them access to major world markets as these large retailers’ work to replace or devalue traditional brands in their home markets.

The intensity of such competition for their traditional markets naturally drives a range of reactions from branded producers worldwide who have invested decades and in some cases centuries into building their brands, markets and distribution networks. One reaction is certainly to lobby for protective measures from their local governments, but the majority of reactions are market focused. Pencil manufacturers worldwide have focused on driving their own cost structures down, placing further pressure on their suppliers as well as looking for more value added products to produce and market. Some in the industry (such as our own company) have even taken to eliminating their home market production and have invested in their own Chinese facilities or relocated to other low cost countries. Some simply now buy their pencils produced to their specifications from Asia.

Finally, another problem is that given the common perception that pencils are simple easy products to produce and Chinese pencil manufacturing equipment can be acquired for a relatively low investment there has been significant new entry of capacity in the past ten years. Today there are over 200 pencil manufacturers in China alone, while the rest of the world has perhaps 100. Often local rural government entities in China will support or even participate in such investments hoping to build up their local economy. Local officials in some cases even look the other way when it comes to safety and environmental compliance regulations.

Given inexperienced management or technicians in some such companies producing a good quality product is difficult and differentiating on anything other than price nearly impossible. Some of these companies cannot and may never be profitable, yet somehow they survive from year to year adding capacity onto the market and holding prices down. So though some old large scale state owned pencil factories in China have closed in recent years due to their higher social cost structures, such behaviors do not indicate to many countries that there is a true market economy developing in China or that dumping of pencils is not occurring.

Clearly there are challenges for both Chinese and traditional brand manufacturers around the world. As price competition has intensified due to pressure from increasingly powerful retail distribution channels, pencils have been increasingly commoditized. While consumers may have benefited some from lower prices, the typical Chinese pencil though improving in quality over prior years still represents a step down in quality from the average quality of product previously available in western markets. Those who achieve the best combination of cost control while maintaining and improving quality and finding new value added products and services to differentiate their business from the pack will come out on top.

My next post tomorrow evening will cover the two key trade policies in China that work to support Chinese producers to gain advantage in the world market.

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