• America appears to have shot itself in the foot in its trade war with China, with major Chinese clothing manufacturers set to be among the biggest beneficiaries.
  • Bigger Chinese suppliers began building a presence in Vietnam three to five years ago ahead of the Trans-Pacific Partnership (TPP) trade deal.
  • China-based manufacturers can mitigate the impact of the new duties by being smart on rules of origin (RoO).
  • A reduced tax burden and depreciating currency have given Chinese exporters flexibility to reduce their prices.
  • Automation is another strategy for larger Chinese firms seeking to consolidate their position during the trade war.
Chinese suppliers are already working with US brands to share the tariff burden

Chinese suppliers are already working with US brands to share the tariff burden

The intensifying trade war between the US and China is proving to be an opportunity for some larger Chinese clothing manufacturing firms who have been building capacity overseas, notably in Southeast Asia – especially Vietnam. 

These companies have been able to adjust to worsening tariff barriers in the US market for China-sourced exports, whereas smaller companies unable to afford new SE Asia operations have suffered. 

Smaller Chinese garment firms are likely to close as a result of the trade war, ceding market share to the bigger firms, according to Dennis Lam, an analyst at the Hong Kong offices of DBS Bank, who covers listed Chinese garment firms. 

"From a multi-year point of view, companies were almost going out of business anyway. The TPP [Trans-Pacific Partnership] was going to wipe them out. Bigger firms already built a presence in Vietnam three to five years ago...brands were encouraging them to build capacity there."

Price cutting

Price cutting by smaller Chinese operations may be a short-term phenomenon by smaller firms seeking to hold onto US customers. Around 50% of respondents to the 2019 US Fashion Industry Benchmarking Study said their Chinese vendors have "lowered their price to keep sourcing orders" during the tariff war, notes Dr Sheng Lu, associate professor in the Department of Fashion and Apparel Studies, at the US University of Delaware. 

"However, such a pricing practice may not be sustainable...as China is no longer regarded as a 'cheap place' to make garments and some major cost factors, such as wage levels, have been rising quickly in the country," adds Lu, who conducted the study in collaboration with the US Fashion Industry Association (USFIA).

According to Lam, larger Chinese garment and textile companies have not been competing on price for some time. "Brands like Nike, for instance, like to work with vertically-integrated suppliers." For such buyers, "therefore, it's very hard to shift" to new suppliers.

Rules of origin

One way in which all China-based manufacturers can mitigate the impact of the new duties is by being smart on rules of origin (RoO). Lam points to sweaters for instance, given that under US RoO, when considering whether they are made in China (and hence attracting the new tariffs) or not, "it matters less where the panels [of the sweater garment] are made but where they are linked up." 

Exporter flexibility

The Chinese government may also have been helping suppliers already working with US brands to share the tariff burden. "Among other things, China has reduced the tax burden on its exporters and weakened its currency," notes Dan Harris, managing partner at Harris Bricken, a Seattle-based law firm long focused on China.

"These two things, among others, have given Chinese exporters flexibility to reduce their prices. Also, many realise that if they do not reduce their prices, their buyers will, and are, going elsewhere." 

Indeed, Harris stresses that most of his company's clients that do contract manufacturing in China – clothing companies included – "are buying from China with one hand while moving production or looking to move production outside China with the other."

Another form of government assistance is Chinese Yuan Renminbi CNY/RMB depreciation – "this helps the margins a lot," notes Harris. That said, many economists say China's capacity to manipulate its currency is limited by the worries over too much capital exiting the country, reducing liquidity and growth.

The Chinese domestic market also can soak up some excess capacity from local garment firms. "Chinese manufacturers are becoming more comfortable selling locally because supply chain practices in China are becoming more internationalised," notes Lam. "In the past suppliers preferred export markets due to lower credit risks and less supply chain corruption."

China for China production

There is indeed much at stake for international brands in China: multinational companies (non-Chinese) accounted for almost half of the top 30 brands in apparel and footwear in China in 2018, according to data compiled by McKinsey. The equivalent figure in the US is 9%, suggesting the allure of international brands in China.

This is why some manufacturers have been careful to keep China production for Chinese market access, according to Chris Devonshire Ellis, principal and founder of Dezan Shira, a business consultancy with offices in China and Vietnam. 

He sees "some spillover also into Africa and BRI [Belt and Road Initiative] nations, especially Russia." Russia had already responded to western sanctions by aligning its supply chains with Asia and away from Europe, he adds.

In the longer term, however, the trade war will merely entail moving US-bound production to SE Asia according to Devonshire Ellis, who believes a "brutal" approach by Washington will ultimately ensconce Chinese integration with some lower-cost Association of Southeast Asia Nations (ASEAN) countries, to the benefit of the Chinese economy.

Increasing competitiveness

Yet while Vietnam is clearly a key destination for Chinese garment makers, it is also clear that these manufacturers have taken other steps to increase their competitiveness. 

Automation is another strategy for larger Chinese firms seeking to consolidate their position during the trade war. One of the larger Chinese firms, Weiqiao Textile, recently announced it was building a CNY820m (US$116m) spinning and weaving line at one of its Chinese plants, which will cut worker numbers by 90% for equivalent output.

A third of the world's labour-intensive manufactured exports are currently sourced from China, while Vietnam accounts for only a 4% global market share, according to a June 2019 research report from the Hong Kong offices of Natixis, a French investment bank. That suggests China maybe holding market share in products, such as garments, despite the trade war.

Tariff experience

While the latest tariffs on many clothing lines have not yet been applied – they come into force on 1 September and 15 December – it is worth looking at the reaction of suppliers and US buyers in cases where tariffs have already been applied to assess importers' willingness to pay these tariffs. 

For instance, 90% of US buyers of specialised metals for the aviation industry are paying the tariff on their Chinese supplies. "It's purely a function of how hard it is to get it elsewhere," says Lam – although that consideration will vary according to the clothing and textile product concerned.

For its part, US department store retailer Macy's Inc recently said it had no plans to increase its prices on any items affected by the next tranche of tariffs.

Its CEO Jeff Gennette said the retailer "did play with selective price increases" in categories like luggage, housewares and furniture following the imposition of Tranche 3 tariffs of 25% in May. But "we learned from that experience that the customer had very little appetite for those cost increases."

However, while he said there are no plans to increase prices on products hit by an extra 10% punitive tariff, if the tariff rises to 25%, "you are dealing with a whole other series of dynamics."

Trans-shipments

Meanwhile, there is increased wariness on the US side over Chinese companies shipping product through Vietnam or other third countries. 

"Illegal trans-shipping is a serious crime in the United States and US customs is well aware this is happening, and it is working hard to stop it," Dan Harris notes. "We encourage our clients to make efforts to confirm that the products they are buying from Vietnam or Cambodia or Sri Lanka or Thailand or wherever actually come from those countries and not from China." 

That said, he adds: "Near as I can tell, this is actually less of an issue with clothing than with many other product items."

One reason why this might be the case: "The Chinese don't need to do that as they are already well established in ASEAN and have been for over a decade," claims Devonshire Ellis.

"They're well prepared for the trade war and can and will sit it out. It's not entirely coincidental that they've been so active with trade deals," such as the ASEAN-China Free Trade Area (ACFTA) deal. 

He recalls a Chinese trade minister ten years ago suggesting that one day the US would have a trade war with them, "and now it's come true."

He tells just-style: "They have been prepared. In five years' time, the US will go after India too. And Washington grumbling about ASEAN will start in two years. Just you see." 

As reported on just-style last month, Chinese upstream fibre, yarn and fabric producers have been ramping up production ahead of a potential slowdown in exports of apparel and other textile products. 

Yet experts are also confident that a wholesale shift of production outside China for dyeing, printing and finishing of synthetic fabric is unlikely.

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