China's toy industry must innovate through brand creation and by optimizing its structure

　　By FENG JIANHUA

　　Blowing away the dark clouds caused by massive worldwide recalls of Chinese toys isn't going to be an easy feat. "We have recalls every year, but none can compare with this year," C.M. Leung, Managing Director of Lung Cheong International Holdings Ltd. (Lung Cheong Holdings). "Made-in-China products have been deeply hurt."

　　From August to the beginning of September this year, the largest toy company in the world--U.S.-based Mattel Inc.-issued three recalls of over 21 million toys produced by Chinese manufacturers in just one month. Later, Mattel admitted that the biggest contributor to the recalls was flawed design aspects-including small magnets that can be harmful if swallowed-of the products and that this wasn't the fault of the Chinese manufacturers. While lead paint recalls made up a sizeable proportion of the tainted toys, defectively designed toys were the larger proportion.

　　On August 11, nine days after Mattel's first recall of 967,000 plastic toys containing lead paint, Zhang Shuhong, Vice Chairman of Lee Der Industrial based in Foshan City, Guangdong Province, where the toys were manufactured, committed suicide. The company had enjoyed a good reputation around the city, but quickly went bankrupt, and 2,500 employees were laid off after the recall.

　　Around 80 to 90 percent of Mattel products are manufactured in China. Mattel and Lee Der had cooperated over the last 15 years without any major difficulties. Lee Der had won the trust of the U.S. company because of its efficiency and the high quality of its products.

　　A blessing in disguise

　　Statistics from the Guangdong Customs Bureau show that in September Guangdong toy manufacturers exported $710 million worth of toys, $5.78 million less than the month before. It was the first negative growth for Guangdong toy makers this year. Growth of Guangdong toy exports to the European Union also declined in September.

　　On September 21, Mattel's executive vice-president of global operations, Thomas Debrowski, issued an apology in Beijing about the recall of the defectively designed toys, and said Mattel was willing to shoulder full responsibility for the recall of those toys. Debrowski's remarks somewhat lifted the burden of responsibility on China's toy manufacturers, but the damage had already been done.

　　Latest statistics indicate that Guangdong's toy industry has gradually shrugged off the negative impacts from the recalls and that exports are picking up again. Guangdong's toy exports in October grew 27.6 percent year on year; against a 5.4-percent increase in September following the recalls.

　　Chen Lipeng, Director of the Guangdong Fair Trade Bureau, was discontent about Mattel's apology. "The incident has deeply hurt the reputation of Chinese companies and caused them huge economic losses," he said. "A simple apology won't help repair all the damages." Chen stated that he was in talks with both Chinese and American lawyers and was willing to help Chinese companies launch a transnational lawsuit against Mattel.

　　However, the most pressing task for Guangdong's toy makers is not finding justice, but how to survive in the future. Leung said that contract original design manufacturers (OEMs) were hit hardest during the recalls. These contractors share common features: low cost, low profit, and poor risk aversion.

　　"On a positive note, the recalls will stimulate the transformation and restructuring of Guangdong's toy industry," Leung said. "Some small companies lagging behind will be wiped out, while the surviving companies must improve the technology of their products and carry out independent innovation. It is conducive to the industry." Leung said that companies that are truly attuned to the needs of the market and continue innovating will enjoy better development potential.

　　"The recalls might not be a totally bad thing," Leung said.

　　Vicious competition

　　In the 1970s, when Hong Kong's industries boomed, human resources costs also soared. It was then that the mainland began the process of reform and opening-up. Looking to cut its costs, many of Hong Kong's labor-intensive industries transferred over the border to Guangdong Province. Lung Cheong Holdings was one of those companies and has been an internationally recognized toy company listed in Hong Kong for the past 10 years.

　　Based in Dongguan City, Lung Cheong Holdings is situated less than 100 km from Hong Kong. The city has over 2,000 toy companies and enterprises related to them number over 5,000. The toy industry is one of the eight pillar industries for Dongguan.

　　About 90 percent of the toys produced in Dongguan are exported, according to a report from the city's administrative department. China manufacturers about 70 percent of the toys on the global market, and 30 percent of those come from Dongguan. Hong Kong-invested toy companies comprise 80 percent of all toy manufacturers in Dongguan.

　　Most of the toy manufacturers process toys for foreign brands, meaning they are small in scale and low in profit. A Dongguan research report reveals that, only 2 percent of the 649 toy companies surveyed in 2004 had their own independent brands. "Most of them don't have their own core technologies," the report stated. "They lack innovation, and their equipment is old."

　　In recent years, the cost of manufacturing has risen due to the appreciating Renminbi, the Chinese currency, new regulations and a shortage of skilled workers. Some toy companies, finding hard to sustain themselves, have moved to less-developed inland regions, as well as to neighboring countries such as Indonesia and Viet Nam.

　　Under such circumstances, some toy companies cut their prices to the minimum in order to secure orders. "The low cost has forced some toy companies to choose unhealthy raw materials which will cause damage to consumers and this is also one of the reasons for the rising numbers of recalls," said Leung.

　　Innovation is key

　　Since most of the products are foreign branded, the profit ratio of Guangdong's toy industry floats at only around 1-3 percent. Moreover, increasing technical barriers from the United States and European Union have added pressure to the industry. For instance, the European Union has issued stricter standards covering six toxic ingredients including lead, hydrargyrum, cadmium, hexavalent chromium and PBDEs. It also ordered that after the toys are discarded, producers and distributors must recycle and pay for the disposal.

　　Significant changes have taken place within the toy industry. Many small and medium-sized companies are worried about how to obtain licenses and qualified inspection reports, leading to nose-diving revenue. However, the order sheets of some large companies have increased 50 percent compared to the period before the Mattel recalls, and they have to work day and night to fulfill the orders.

　　"The changes have made many companies realize that price wars no longer work as they did before," Leung said. "If you want to survive, innovation and continuous efforts to increase added value are essential."

　　After years of development, the technology level of the Guangdong toy industry has reached the international standard. Generally speaking, toy quality there can be guaranteed. Statistics show China exported 300,000 batches of toys to the United States in 2006, and of these, there were only 29 cases of recall.

　　Eyeing the future

　　The Mattel toy recall incident has taught many toy companies a lesson, and some local governments have begun efforts to upgrade these industries. Xiao Naixiong, a policy research officer of the Dongguan SSL Science&Technology Industry Park, said that the city government is conducting a survey among Dongguan's toy-manufacturing companies, and, based on this, it will issue a report involving policies encouraging the upgrade of the toy industry.

　　In order to do this, the Dongguan Government is striving to build sound platforms for companies and research institutions to develop a new generation of hi-tech toys. The Guangdong Electrics Industry Institute (GEI) is one such platform. Tang Zhenchu, Vice President of the GEI, said the institute has invented system-on-a-chip technology that can reduce the cost of intelligent toys from several thousand yuan to several hundred yuan.

　　Tang said many toy manufacturers are interested in this technology and will soon negotiate for cooperation possibilities.

　　Large toy manufacturers have already realized the importance of upgrading their products. Lung Cheong Holdings is a typical example.

　　The company started as a small workshop in Hong Kong in the 1960s and manufactured toys under other brands. Eight years later, the company bought second-hand plastic processing equipment to produce Christmas trees. Through cooperation with big Japanese toy companies like Taiyo and Tomy, Lung Cheong Holdings became recognizable in the industry.

　　In the early 1970s, Lung Cheong Holdings moved its factory to the mainland to cut costs, while the Hong Kong headquarters remained responsible for product research and marketing. Since its listing in Hong Kong in 1997, the company has enjoyed sufficient capital and has been able to direct more attention to hi-tech toys.

　　"The profitability of traditional toys is very low, while that of digital hi-tech toys can reach 30 to 40 percent," said Chen Yuchuan, a senior manager with Lung Cheong Holdings. "The market teaches us we must innovate in order to survive."

　　Leung said that 3 to 5 percent of the company's 800 million yuan in annual sales revenue will be dedicated to research and development. Currently, the company has about 6,500 employees and around 320 are engaged in research and development, covering every aspect of toy production.

　　In Leung's company, original equipment manufactured (OEM) toys account for 50 percent; original design manufactured (ODM) toys make up 25 percent; and original brand manufactured (OBM) toys take 15 percent.

　　"Our goal is to increase our OBM to 50 percent in the next five years," Leung said.