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On China’s Factory Environmental Audits

What Are the Challenges, Opportunities, and Predictions for China Manufacturing?

Under President Xi Jinping, China manufacturing is on a mission to improve environmental governance. Given the multitude of environment issues facing the country, particularly its notoriously prominent levels of air and water pollution, the administration is pursuing environment diplomacy at the global level while also imposing rigorous regulations back home.  The process begins with sweeping environmental audits at factories across many industries and sectors.

In the final months of 2016, environmental authorities issued a red alert across 23 northerly cities after air pollution skyrocketed 50 times above the World Health Organization’s safety limit. It was reminiscent of a severe smog episode in 2013 which had brought life to a standstill and forced urban residents to flee to the countryside in search of better quality air. The government responded by closing over 1,000 factories, mostly steel production facilities, many of which have remained abandoned.

China’s Environmental Protection Law allows the Ministry of Environmental Protection (MEP) the authority to exercise strict action against factories and organizations deemed to be heavy polluters. Fines on polluters have become more severe.  Under the new method, the fine is calculated for the number of days that the factory pollutes, starting from the day after which it has received a notification from the MEP, and until it has resolved the problem. In 2015, factories in Taijing were fined approximately 60 million RMB, almost 2.3 times the amount fined the previous year.

Authorities have zeroed in on urban areas around Shanghai, Beijing, and the Pearl River Delta in South China. The main manufacturing areas affected by audits and subsequent closures include Jilin Province to the north, Zhejiang Province to the south, as well as the inland islands of Chengdu and Chongqing. Several thousand factories have either shuttered completely, or closed temporarily with no definite time-frame on when they will be back in operation.

Impact on Supply Chain & Shipment

The metal industry is among the hardest hit. Authorities are going after aluminum producers who have been unable to meet environment regulations implemented in 2015. It was recently reported that aluminum smelters in four provinces around Beijing will be forced to slash output by 30 percent during the winter months of November through March. Analysts estimate a reduction in output of up to 1.3 million tons.

METALSChina manufacturing of aluminum rose to a five-year high after investors swarmed to the market on prospects that lower capacity by the world’s largest producer of the metal would tighten supply. Lower production is also expected to impact raw material suppliers and hit the global aluminum supply chain.

It is ironic to note that both the environment audits and capacity management come at a time when criticism around the country’s excessive aluminum and steel outputs has grown louder. There have been calls to curb the overcapacity by the US Aluminum Association, Aluminum Association of Canada, and European Aluminum. The issue has also been brought up at the G20 summit, where the associations have accused excess capacity and downward effect on prices of creating employment and economic losses for their producers and economies.

The capacity closures have led to an uncertainty in the global aluminum supply chain, which has historically not faced the kind of headwinds that the steel industry is intimately familiar with. It doesn’t help that the disruption is coming at a time when aluminum usage has risen in key sectors such as transport.

China has already been successful in ramping down coal usage, which currently accounts for 70 percent of the country’s electricity. Consumption of coal has dropped continuously over the past three years and fell by 4.7 percent last year.

In other affected industries such as rubber, chemicals, plastics, coating, and textiles, suppliers themselves are under scrutiny. The crackdown on various supply chain links is an additional headache for manufacturers who have no choice but to remove certain components from the production, or modify their products. Manufacturers may also have to contend with production delays, or struggle to make accurate predictions on delivery lead times, even as they focus on finding a replacement.

Some companies are dealing with the shutdown by moving their manufacturing to factories in Thailand, Vietnam, or India, though they acknowledge that China’s robust network of factories and suppliers will be tough to match.

The factory closures couldn’t have come at a worse time. Besides being disruptive to normal business operations, holiday shipping is likely to be severely affected. With the holiday season in Europe and the US, as well as the Chinese New Year, companies are in for a tough time this fourth quarter and beyond.

Cost Impact

In 2016, phosphate fertilizer producers in Hubei underwent a stringent environment audit with some having to temporarily halt production. The local government also enforced lower operating rates – between 20 to 50 percent – on some producers.

The fourth round of audits started at eight phosphate provinces in August this year. Fines and issue rectification within a defined time-frame have seen cash costs rise. Big phosphate producers such as Wengfu and Yuntianhuan, have invested millions of RMB towards environmental treatment. Smaller producers that lack the money power to respond swiftly have inevitably had to face fines and disruptions.

To counter the impact of audits, phosphate manufacturers have lowered operating rates or closed temporarily to avoid any potential problems during the period of inspection.

Manufacturers who fail to implement environment-friendly practices and reduce their pollution output will either need to somehow absorb the fines, or increase the cost of their products. Both would be counterproductive in the long run, adversely affecting net margins, as well as their competitive advantage.

Companies that have maintained strong relationships with their suppliers can encourage them to incorporate the necessary changes to improve environmental credentials and avoid financial penalty. Though the initial investment may be substantial, it will pay off in the long run.

Impact on Brand Reputation

Brands linked to environment pollution get bad press, but how exactly it affects their profit margins is lesser known. In China’s burgeoning textile industry, the likes of Zara, Puma, and Armani have been accused of partnering with polluting factories to manufacture their apparel. Big brands have escaped intense scrutiny by announcing sustainable initiatives and publishing audit reports.

For importers that distribute major labels, environment compliance can be bothersome if a major incident prompts consumers to switch to more Eco-friendly brands. More than ever before this is likely to occur in today’s high Eco- and health-conscious consumer landscape. Importers can look at labels that contract compliant factories or – if they wield enough influence – encourage suppliers to proactively engage independent auditing firms to report on environmental management systems and other green initiatives that help create a positive brand image. For instance, they can focus on ISO 14001, a highly recognized standard acknowledging an organization’s commitment to continuously improving environmental performance.

Following a criticism of their environmental record in China, Apple Inc. in 2012 joined forces with the country’s Institute of Public and Environmental Affairs (IPE) to audit its Chinese supply chain for pollution. In 2013, IPE published a report detailing the technology company’s improved environment oversight program focusing mainly on its move to a much better supplier environmental supervision that it achieved by incorporating some key components of a model supply chain.

What Will Become of Low-Cost Manufacturers?

China’s anti-pollution drive is expected to weed out low-cost manufacturers who subsist on small profit margins and do not have the financial resources to invest in Eco-friendly production practices. There has been no effort to understand how to implement green solutions while also saving money. Consultants are of the opinion that assembly factories should cut ties with risky suppliers and pay the extra costs of working with environment-conscious businesses. This strategy should be analyzed broadly given that the environment audit covers tier 1, 2 and 3 suppliers.

For low-cost manufacturers of low-value items, a move out of China to other Asian countries may be in the cards. It could be exactly what Chinese authorities want in their goal of driving producers up the value chain and making the country’s skies blue again.

China’s new mindset on environmental sustainability was bound to be painful for its China manufacturing industries, but it has also forced quality assurance upon them. That being said, it will be a while until we understand whether the factory closures have a long-standing impact on manufacturers and distributors. And with the crackdown eliminating excess capacity and forcing prices higher, big players compliant with environment requirements will find themselves in a stronger position. If these factories can seize the opportunity to boost profits, the government will have more incentive to continue on their path to environment reform.

At ITI Manufacturing, we know you like to stay abreast of the news and China’s economic impact on overseas manufacturing. We also have nearly 50 years of expertise to guarantee China manufacturing success to US-based companies looking to outsource their products. Despite possible downturns and changes, ITI is here to help you navigate through and win in the China manufacturing process. Call us today- 888-574-6823.

By | 2017-12-04T17:58:09+00:00 November 29th, 2017|Chinese Manufacturing|

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