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China Cost Increase Real?

 

By Dominator Export Fireworks Co.

Dec 10, 2007

I am in China right now working through the issues personally.

The series of events have gone as follows:

There have been approximately 86 deaths across China in the recent months in fireworks factories.    There was a serious accident at the Dahu factory several days ago, which resulted in about 11 deaths (don't have the official count).  This was the most serious accident in Liuyang since the 1990's.  

From what I have been told, the accident occurred because they were loading lift powder and inserts into cakes in a crowded assembly workshop. About 20 workers were in the workshop at the time.  The current regulations require that lift powder and lose stars need to be loaded on the powder line, where only one worker per hut is allowed to work.   

Why did the factory break the regulation? Because they were rushing to try to get the order out during this very busy season where both China domestic product and USA product is being produced.  If they are late on delivery, they might as well not bother.

They need this volume because they are being squeezed very hard by competition and margins are lower then ever.  Liuyang has over 500 registered factories. Just 30 minutes away Liling has another 500 factories.  These are only the registered factories; smaller domestic factories that are not registered for export number in the thousands.   So competition is fierce.   

The free market forces work very well in the fireworks business. For example, as production costs have been raising steadily, the full impact of these costs have not been passed onto the importer yet.  The factories and the export companies have absorbed some of these cost increases, the reason, competition. As factories have seen material and labor prices rise, they have not been able to fully recover these increases from the export companies. The reason is because the export companies are seeing their own cost increases in the form of RMB appreciation and tax increases. So competition pushes real margins down for factories and exporters. 

The Liuyang Fireworks Manufacturers Association is an association similar to APA, however it has roots in the government.  So it has powers to penalize non-conforming factories.  The leadership in Liuyang changes every 5 years and this is the first year of the new leadership... so they are establishing themselves and testing their powers. 

The Liuyang Fireworks Branch of the Government and the Liuyang Fireworks Manufacturers Association held an emergency meeting last week and announced new safety policies and voted mandatory price increases to support those new policies.  Over 1,000 leaders from local factories and companies were crammed into a movie auditorium for the meeting.

The vision of the leadership, from what I can gather, seems to be to try to stop the downward spiral of price pressure through regulation. They are using the 11 deaths at Dahu as an example of why artificial price limits need to be placed on the factories in order to maintain a certain minimum safety standard. They have also stated a policy of encouraging consolidation of small privately owned factories into larger "groups". These groups would have less competition and therefore would be able to maintain higher price points and theoretically would be able to apply some of this extra money to measures that would improve safety.  Whether this will actually happen, or if the extra profit will just go to lining someone's pockets, is another question.

In the short run, factories are now contacting the export companies and trying to raise prices on any new orders after December 1st.  Some factories are threatening to cancel orders that have been placed for the July 2008 season and trying to re-negotiate them. For me at least, the principle of no new price increases for the current season is holding in heated negotiations. However, it is clear that costs have continued to rise dramatically even in the last several months.  If the government does take a heavier hand and requires that all safety regulations be met, that will mean a real and immediate cost increase for the factories as the number of workers per assembly building, powder limits, etc. will all reduce.  

As we speak, production for the USA season has come to a serious slowdown as factories have been notified that surprise spot inspections will be occurring over the next several weeks.  All factories will be visited.  Fines and criminal penalties could be harsh.  My factory production managers are warning that there could be delays versus my production plan, however we continue to load containers daily and have not come off plan yet.  

At this point I want to emphasize that the events are changing daily and what this actually means for the coming season, and future seasons, remains a completely open question.

The one thing I think I can safely say is to be prepared for more significant change in the fireworks industry in the coming months.  I had really hoped that the worst was over and that we could enjoy at least another couple of seasons of relative price stability.  However, sitting here today in Liuyang, I would have to say that my job has just become a huge guessing game and volatility will be with us for coming season. 

See other articles of interest:

End of the golden age of importing

China Currency & Fireworks

Living the dream in Liuyang

 
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