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China's Outsourcing Appeal Dimming

Fuel Prices Squeeze Profit Margins for U.S. Manufacturers
By Ariana Eunjung Cha, Washington Post
September 08, 2008

SHANGHAI -- Harry Kazazian built his business on sleeping bags that are made in China and shipped across the ocean to the United States, but he realized recently that the math doesn't work anymore.

With fuel prices at record highs, the cost of sending a standard 40-foot container of goods has gone from $3,000 in 2000 to about $8,000 today, squeezing profit.

So this summer Kazazian, chief executive of Exxel Outdoors, a Los Angeles-based maker of recreational equipment, did something radical: He moved the manufacturing back to Haleyville, Ala.

Soaring energy costs, the falling dollar and inflation are cutting into what U.S. manufacturers call the "China price"-- the 40 to 50 percent cost advantage once offered by Chinese producers.

The export model that has powered China and other Asian countries for three decades will be compromised if fuel prices continue to rise, said Stephen Jen, a managing director for Morgan Stanley.

"Globalization has gone a little bit too far. It has overshot," Jen said. "We're not saying Asia is going to crumble, but we are saying Asia enjoyed extraordinary conditions in the past. Now the conditions are changing very quickly because of the energy shock, and Asia is coming under pressure."

The ripple effects have been far-reaching. The trade imbalance between the United States and China -- a source of political tension for years -- is beginning to right itself as Chinese exports fall and U.S. exports rise. Global trade routes are being transformed, suggesting a possible return to a less integrated world economy.

The model of outsourcing to China emerged at a time when oil was going for $20 a barrel. In the past few months, oil has been trading at about $110, and many experts say it will eventually hit $200.

This has led some companies to move production from China to northern Mexico, next door to the U.S. market. But others have chosen to relocate inside the United States.

Midwestern steelmakers are doing booming business as steel exports from China to the United States slowed down by 38 percent in the first seven months of the year while U.S. steel production rose 10 percent. Manufacturers of furniture, electronic appliances and textiles are also among those shifting production back.

The most prominent company in the group might be Thomasville Furniture, which was criticized a few years ago for sending several thousand American jobs overseas. It announced in June that it was returning production of an entire line of upholstered and wood furniture to the United States. The company says it will add 100 jobs in North Carolina.

It's unrealistic to think that all or even the majority of factories lost to China will return to the United States if the price of oil continues to rise. A lot of equipment was disassembled and shipped abroad years ago, and it would require a massive reinvestment to move or replace it. And despite the high shipping costs, China still offers advantages: Many raw materials remain cheap, and millions of skilled laborers work for wages that are a fraction of what their American counterparts get.

A survey released in June by the audit and consulting firm Deloitte found, however, that U.S. manufacturers consider locations in North America, including Mexico, the most desirable for expansion over the next three years.

"Instead of finding cheap labor halfway around the world, the key will be to find the cheapest labor force within reasonable shipping distance," Jeff Rubin and Benjamin Tal, economists for CIBC World Markets, wrote in a recent report.

"In a world of triple-digit oil prices, distance costs money," the researchers said. "And while trade liberalization and technology may have flattened the world, rising transport prices will once again make it rounder."

Other factors are helping drive a flight from China: the increasing value of the Chinese currency, the yuan, vis--vis the dollar; a new labor law; the repeal of some export tax rebates; and inflation. Many companies say they are also motivated by a sense of patriotism and environmental concern.

Farouk Systems is moving production of its flatirons, hair dryers and brushes from China to a factory in Houston, creating 1,000 American jobs. "Our profit may be not as high in the short run, but in the long run, we feel it's better to help the U.S. economy," said Jessica Gutierrez, the company's public relations manager.

Sagus International, which owns the classroom furniture manufacturer Artco-Bell, will make its colorful ergonomic desk and chair sets for primary and secondary schools in Texas instead of China. "I think all of us are proud to be Americans," said Stephen Sykes, vice president of marketing at Artco-Bell.

Eight years ago, Kazazian was an entrepreneur producing family-style outdoor gear and looking to expand his operations. Sun Yun was a 25-year-old salesman at his father's down factory in an industrial part of Shanghai who wanted to get into the export business.

They met online in 2000 and started making inexpensive sleeping bags that quickly became a bestseller at Wal-Marts, Kmarts and Targets across the United States.

But as oil prices started to rise, Kazazian began to worry.

Given that 1,800 sleeping bags could fit in each container, Exxel was soon paying about $4.44 to ship a bag that retailed at Wal-Mart for $9.99.

"Even if they made the bag for free in China, it would still be too expensive," he recalled thinking.

Kazazian began to research what it might cost to produce the bags in the United States. The company still had a factory in Haleyville that had been mostly idle for the past few years. He was surprised to find that with transportation costs factored in, it would be 4 to 5 percent cheaper to produce there than in Shanghai.

Last month, he began hiring the first of what he hopes will be 50 new workers in the United States.

Kazazian is working on a plan to cut overall production in China of all his products -- tents, backpacks, folding chairs, tarps, apparel -- from 80 percent at the beginning of this year to 20 percent by the next. Meanwhile, at Sun's factory in China, more than 80 of his 400 employees are being laid off. Rows of sewing machine stations are empty as a skeleton crew works to produce the last batches of Disney-branded sleeping bags before the operation is shut down.

There are purple bags bearing Hannah Montana's image and pink ones featuring Snow White and the Little Mermaid. Camouflage for the boys.

Sun, now the general manager, said he knows there's more trouble ahead.

"This is not just my problem. This is a problem for all of China," he said.

The Chinese economy still ranks among the 20 fastest-growing in the world, even though it has had four straight quarters of decelerating growth. Industry groups in China say tens of thousands of manufacturing companies have shut down in recent months. Official statistics show that from January to May, the growth of labor-intensive exports fell to 16.7 percent, from 29.6 percent the year before.

Morgan Stanley's Jen said that in the short term, high oil prices are "clearly a negative shock to Asia," but that in the long term, they could help China achieve its goal of producing more high-tech goods and becoming more of a service economy.

Sun said he is scrambling to learn how to make more complicated, higher-value products that will be more difficult to produce elsewhere. He's working with Kazazian on a new line of life vests that will be sold in the United States.

He doesn't need to do any complicated accounting to confirm that the vests will be more profitable than the sleeping bags. He just needs to eyeball them. For every sleeping bag that can fit inside a U.S.-bound container, there's room for three or four children's life vests.

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