U.S. toymaker doubles down in China despite rising costs, political tensions

Newsfrom Japan

Jul 2, 2021

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By Gabriel Crossley and Timothy Aeppel

JIUJIANG, China/NEW YORK (Reuters) - Hammered by tariffs, pandemic-fueled disruptions and rising costs, some global manufacturers are reducing their reliance on Chinese factories and moving assembly lines to Vietnam, Malaysia and other lower-cost countries, or even Japan.

But Ryan Gunnigle, the chief executive of Kids2, is swimming against that tide. The Atlanta-based maker of toys and infant products recently opened the first phase of a factory on the banks of the Yangtze river in central China at a cost of $20 million.

China's dense supply networks, still-competitive labor costs, and growing domestic market proved too powerful a draw.

"If you're making wood furniture, Indonesia is great," Gunnigle said. "But for us, being central in China just outweighs any benefit of other markets."

Gunnigle, who oversees a five-decade-old brand, has watched some suppliers and competitors set up shop in other countries - only to move back to China after finding the costs in their new locations were too high or having to deal with labor shortages and difficulties finding suppliers.

"There's definitely a risk" in building a new factory in China, he said. "But our products have sewing, electronics, steel, plastic - and all those things come together well in China."

For many U.S. companies operating in China, the prospect of decamping to another Asian market was not a serious idea until 2018, when rising tensions between Washington and Beijing flared into a trade war marked by punitive tit-for-tat tariffs.

Some Southeast Asian nations saw a chance to lure away American companies with the prospect of lower labor costs and calmer political waters. Even Japan, a G7 economy, got into the act by offering to pay Japanese firms to relocate from China.

The pressure on U.S. companies to reconsider investments in China reached a fever pitch during former President Donald Trump's administration but it is not expected to dissipate much under his successor, President Joe Biden.

U.S. Treasury Secretary Janet Yellen said last month that she expects full "decoupling" in some areas of the economic relationship with China in order to protect U.S. national security. And Group of Seven leaders recently announced plans to work more closely to contain China's economic influence.

'I'LL GET RICH'

Southeast Asia's biggest advantage versus China is that labor costs are lower, said Jack Sun, general manager of the Kids2 factory in Jiangxi province, which has around 450 staff and currently produces around 10% of the company's products.

"But supply chains are no good. In China you can buy anything."

Finding workers in central China is also easier and cheaper than on the wealthier coasts, where most foreign investment has been concentrated. And a factory in China also makes it easier to sell to the roughly 400 million middle-class consumers in its domestic market.

Kids2 launched its products on Alibaba's e-commerce site Tmall on May 18 - a date which, as Sun mentioned, sounds like "I'll get rich" in Chinese. Gunnigle is hoping for 30% annual growth in China sales in the first few years beyond 2022.

China's President Xi Jinping is personally pushing an effort to boost domestic consumption and cut reliance on overseas markets in the face of the rising tensions between Beijing and its trading partners.

Kids2 is among the companies that have been hurt by the tariffs on an array of manufactured goods that resulted from the U.S.-China trade war. The company said it has paid $6 million in tariffs on Chinese imports since April 2018.

Most of those tariffs remain in place. Meanwhile, the challenges of producing in China have continued to mount as the onset of the coronavirus pandemic upset the flow of goods.

Still, China managed to keep its factories humming through most of the last year, even as other locations battled with lockdowns to curb the spread of the virus. Chinese exports, after a short-lived drop in early 2020 during the country's COVID-19 lockdown, have climbed on a year-over-year basis for 12 straight months through May, including a record increase of nearly 155% in February, according to China Customs data.

PRODUCTION CONTROL

Gunnigle said his own board has raised questions about whether he should be looking elsewhere, but he's convinced that the investment in a new plant and design operations in China - part of a revamp of the company's product development system - is key to remaining competitive.

Early in the pandemic, foreign businesses said disruptions added to the pressure to diversify away from China.

Yet a survey released in June by the European Union Chamber of Commerce in China found that member companies were now strengthening positions in joint ventures and onshoring supply chains despite longstanding concerns about limited market access and unequal treatment in China.

Kids2 has long relied on joint ventures with Chinese toy producers and will keep working with those sources, Gunnigle said. But the new design and manufacturing operation that the company has built in China and owns outright gives more power to craft goods, move quickly to organize the production process and invest in needed machinery, he said.

The factory's injection molding machines, which squirt molten plastic into parts for bassinets and brightly colored walkers for toddlers, were further automated this year by the in-house engineering team, reducing required labor by nearly 60% and cutting costs much more than other local suppliers have, Sun said.

And on the assembly line, located on the other side of the factory, the process of screwing, riveting, and packing can all be further automated without much trouble, Sun said.

Gaining more control over how products are made creates many advantages. About 40% of Kids2's business is now e-commerce, which means designing toys to minimize their size and weight and accommodate shipping is more important than ever.

Control over the production process also makes it easier for the company to create products that rely on common parts, which drives down tooling and other costs. For example, the plastic cradles in Kids2's swings and highchairs are made using the same injection mold.

David Butler, the company's internal head designer, said the other reason to control more of the production is to involve designers more directly in the decisions that will influence how assembly lines are configured.

"We used to design more as one-offs," Butler said, with designers coming up with a new toy or accessory and then the manufacturing team deciding how to produce it. "Now that we own our own factory, we design differently - with more interchangeable and modular systems. It's the way IKEA designs products."

(Reporting by Timothy Aeppel and Gabriel Crossley; Editing by Dan Burns and Paul Simao)

Employees work on the production line of American infant product and toy manufacturer Kids II Inc. at a factory in Jiujiang, Jiangxi province, China June 22, 2021. Picture taken June 22, 2021. REUTERS/Gabriel Crossley

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