Asian Wall Street Journal
October 6, 2003

Textile-Sector Changes Stir Up Southeast Asia
As End to Quotas Looms, Companies Alter Strategy To Compete With China

By CRIS PRYSTAY
Staff Reporter of THE WALL STREET JOURNAL

BATU PAHAT, Malaysia -- A dozen women wearing Muslim headscarves bend over whirring sewing machines in Prolexus Bhd.'s training room, practicing the most complicated techniques used to stitch the Nike and Gap outfits that are made on the factory floor downstairs.

Workers at this factory, tucked amid the leafy hills that surround this southern Malaysian town, have sewn all kinds of garments for big U.S. brands for 27 years. But Prolexus began outsourcing some of its orders five years ago to a company in Sri Lanka, and it is close to signing a joint venture deal in China. Soon all the basic sewing work will be sent abroad, and only the high-end jobs kept at home. How many jobs survive here will depend on the company's ability to boost productivity and skills.

"It's all about competitive advantage," says Lau Mong Ying, managing director of Prolexus, which employs 2,000 workers at this factory and another, further north, in Penang. "Malaysian workers are skilled, and we need to leverage that. But we've also got to become a regional company if we want to compete."

China's entry in late 2001 into the World Trade Organization, and the looming end of the textile-quota system among WTO members, are reshaping Southeast Asia's textile industry. These developments are forcing companies across the region to relocate basic jobs to countries with lower-paid labor, including China, while pushing the companies themselves to boost productivity and know-how among workers at home.

In 1994 WTO members agreed to phase out by the end of 2004 textile quotas that have restricted global trade in garments since they were imposed in 1974 by European and North American countries. This is expected to increase the dominance in this sector by China, which enjoys economies of scale, low-cost labor and an integrated domestic industry that spans cotton farming to clothing design. The World Bank estimates China's share of global clothing exports will more than double to 47% by 2010 from 20% today.

China has already seen big gains in the few categories that have gained quota-free status in recent years, such as brassieres and dressing gowns. China's textile and garment exports to the U.S. market more than doubled to $4.96 billion in 2002, and the American Manufacturing Trade Action Coalition predicts a doubling this year.

The trend is spurring companies like Prolexus to rethink traditional manufacturing practices. About 40% of Malaysia's major garment manufacturers have opened new factories in China or in countries such as Cambodia in the past few years in search of lower labor costs, industry executives say. China's dominance of the market is even squeezing some other low-cost countries. Cambodia's textile industry, for example, has focused on niche categories, like women's knitted apparel, where China has been constrained by the quota system.

The end of the quota system could spell bad news for such countries. Elena Ianchovichina, a senior economist at the World Bank, says she is especially concerned about Cambodia. "They've been operating in narrowly defined niches, and they'll have to go head-to-head with the Chinese in a market that hasn't even been tested by competition," she says. Cambodia has just been approved for membership in the WTO, and neighboring Vietnam hopes to join by 2005. If Hanoi's membership isn't sealed by then, Vietnam will still face quotas from the U.S.

The absence of upstream industries could hobble Southeast Asian textile and garment companies. China, India and Pakistan have their own domestic cotton industries, giving them an advantage over Southeast Asian countries, which must import raw materials, says Robin Anson, managing director of Textiles Intelligence, a London-based publisher of business information on the global fiber, textile and apparel industries.

"I think all countries in the region will suffer. There are brakes on the supplies, and when you take the brakes off, nobody is going to hold back. You're going to get oversupply and prices are going to fall," says Mr. Anson. "It's going to be a question of which countries are best able to survive. The ones that will are those with an integrated supply chain, low labor costs and a fairly efficient production system."

Tumbling Prices

Malaysian manufacturers are already feeling the impact of tumbling prices. The value of the country's garment and textile exports fell last year to 11.7 billion ringgit ($3.08 billion), 13% below what they were two years earlier. The Malaysian Knitwear Manufacturing Association blames stiff global competition, which has driven down prices in markets such as the U.S. by about 30% in the past five years.

Regionalizing operations could help save Malaysian companies, but it could also slowly choke the domestic industry if downstream suppliers in Malaysia start to go under, says the association's president, Seow Hon Cheong, who also serves as director of Trans Pacific Industries Sdn. Bhd., a manufacturer of sleepwear for a U.S. company.

"So far, we're lucky. They're scaling back, rather than closing down. None of us are thinking of relocating entirely," says Mr. Seow. "But most companies are planning to do at least the lower-end work in a lower-cost developing country."

Prolexus already is. The company, which posted $45 million in revenues in the year ended July 31, 2002, and makes clothes for Fila, OshKosh and Puma as well as Nike and Gap, began outsourcing orders five years ago to a company in Sri Lanka. That company now accounts for about 17% of Prolexus sales.

Six months ago, Mr. Lau of Prolexus began searching for a partner in northeastern China, where wages remain lower than in prosperous coastal provinces further south. He is close to finalizing a joint venture agreement with a mill in the northeastern city of Shenyang, and is looking for a second partner further south, in the provinces of Jiangsu or Zhejiang.

"We can't compete on labor costs. Labor at the [northeastern] China factory costs 50% less than [in] Malaysia," says Mr. Lau.

Prolexus doesn't plan to scale down its manufacturing operations at home just yet, but the nature of the work done there will change, Mr. Lau says. The Malaysian operations will increasingly focus on marketing, product design and on high-end orders that call for expensive, advanced materials, such as fabrics that offer untraviolet-ray protection and that require higher-skilled workers. "Our workers here are more skilled. In terms of efficiency, productivity, we're still ahead," Mr. Lau says.

Two years ago, Prolexus executives started looking for new ways to ratchet up that productivity to prepare for the post-quota era. Half the factory was already semiautomated with a computerized moving hanger system that delivers each garment piece to the right seamstress, then moves it along to the next one. Prolexus added new machinery, including giant, automated cutters that cut thick bales of fabric into ready-to-sew pieces, and scanners that detect broken needles in finished clothing. It invested 1.5 million ringgit in enterprise resource planning software, which allows the company to electronically take and track orders and payments. The software also allows Prolexus to track customers' stock and generate orders automatically, an arrangement option that it is now discussing with Nike.

Streamlining Production

Mr. Lau also created a four-person industrial-engineering department to help streamline production. The engineers gave factory workers swiveling ergonomic chairs that not only reduced fatigue but also helped shave crucial seconds from the time it takes to turn and pick up a garment piece from one pile and drop it onto another, after a particular bit of work is done. They also introduced a training program to teach new workers and upgrade the skills of existing ones. Such efforts have improved productivity by about 10% to 15% in the past two years, Mr. Lau says.

Investing abroad has brought its own perils. Two months ago, Prolexus decided to shut a factory it had set up in Bangladesh two years earlier that had proved unprofitable. Labor costs in Bangladesh are a fraction of Malaysia's, but the country's poor infrastructure doomed the investment, Prolexus executives say.

"It's difficult to get things like a telephone line or water supply. There are constant blackouts," says Willie Gan, executive director of finance at Prolexus. "And then there's port congestion. Sometimes it would take a week to clear our goods."

Prolexus executives even remain wary of investing in China. Mr. Lau worries that as anti-China sentiment grows among U.S. manufacturers, Washington could slap new trade barriers on the flood of Chinese imports into the U.S. A coalition of U.S. industry associations is already pushing for some sort of protection on quota-free items like dressing gowns and brassieres. And if Washington succeeds in its bid to force China to revalue its currency, the cost benefits that China would provide to Prolexus could evaporate overnight.

Labor costs in China might be half of those in Malaysia, but factory labor comprises just 10% of Prolexus's total costs. Material, which is sourced from around the region, accounts for 40%, and overhead, including machinery, another 40%. Mr. Lau estimates that his China investment, including the lower labor cost and slightly lower overhead, will deliver a 15% savings, a figure that has to be weighed against a potential jump in duties.

"Quotas are one thing, but duties are another," he says. "It's something we need to watch."

Prolexus executives, meanwhile, are keeping an eye out for investment opportunities in any countries that are likely to strike individual trade agreements with key export markets. Sri Lanka, for example, is in the midst of negotiating its own free-trade agreement with the U.S. It is unclear how the textile industry will be affected, but Prolexus's outsourcing deal gives the company a foot in the door, Mr. Lau says.

The Malaysian Textile Manufacturing Association is leading its members on a trade mission to Sri Lanka in November. Mr. Lau plans to go along to look for potential joint-venture partners. "There's a lot of things to consider: political issues, economic issues, foreign-currency issues," he says. "You've got to spread your risk."

Write to Cris Prystay at cris.prystay@wsj.com

Updated October 6, 2003