The outbreak of Sars in 2002 marked the beginning of a downward cycle for Hong Kong-listed Dream International, one of the world’s largest plush toy manufacturers by revenue. However, Young Lee, the company’s chief financial officer and executive managing director, picked up a wealth of experience from the ordeal.
“The first sign of the downturn was Sars, but more signs appeared thereafter,” said Lee, whose company registered gross profits of HK$252 million ($32.5 million) in 2009. Sars was particularly damaging to the 15% of Dream International’s business focused on original design manufacturing (ODM). Here toys are manufactured according to in-house designs that require customers to visit the company in person to select models. With the largest customer base in the US and manufacturing factories and showrooms in China and Hong Kong, few buyers dared leave the US, said Lee.
At the same time, the east coast of China started to become less attractive to low-cost manufacturers. For one, minimum wage increases of roughly 15% to 16% cut into margins, as did rising material costs, particularly for polyester, acrylic and plastic, which are all by-products of oil — and essential ingredients in the average teddy bear.
The company cannot control the price of oil, but it had other cost-saving options, such as moving to cheaper manufacturing sites. So that’s what it did. It started setting up shop in new factories in Vietnam and in Anhui and Guangxi, in inland China. The problem is that it takes about a year to adequately train staff in a new factory — and low-end manufacturing staff aren’t known for sticking around for more than three months.
The first sacrifice was one of the company’s two Shenzhen factories. One shop within the city boundary of Shanghai was closed in 2007 and a major factory located in the coastal city of Taicang was closed in 2008.
By the second half of 2008, the restructuring was finally showing results as operations started to turn around. “We had made four straight years of losses during the downturn and then it completely reversed. We have announced a profit in our interim results this year and we are running at a much better condition than last year,” said Lee.
Disney story
Having survived Sars and restructuring, Dream International has benefited from a booming original equipment manufacturing (OEM) business. Here, the company is mandated by customers to produce plush toys according to specifications supplied to them. With three factories in Anhui, two in Jiangsu, two in Guangxi, one in Dongguan and one in Shenzhen, there is neither customer nor order that is too big for the company, says Lee.
The US is currently the biggest market for plush toys but Lee says that Japan could become a serious contender in the medium term and China will become the ultimate player in the long term. Dream International’s sales volumes from Japan have increased by 60% to 70% during the past couple of years; Lee thanks sales at Tokyo Disney as the main factor. Such tie-ups remain central to Lee’s strategy. Tokyo Disney and Dream International have an exclusive partnership producing a Japanese favourite, Duffy the Disney bear. Dream International has also won the exclusive rights from the beginning of this year to produce Duffy’s girlfriend, Shellie Mae, both only available at Tokyo Disney.
“Three to four years ago, customers would tell us that we were one of the two thousand or more suppliers that they can go to. Now they do not say that; they have far fewer options to head to and we have been benefitting throughout the financial crisis,” Lee said. Not all of the small toy manufacturers survived the margin crush of the past decade, leaving behind a far more consolidated industry of bigger players and niche service providers to the big companies. For example, Dream International buys all manufacturing materials and then farms out the production of separate parts to smaller factories. In-house factories then assemble the final product.
Lee’s business plan involves as many small manufacturers as possible — by outsourcing, he can take on more business without managing the overhead costs of each component supplier.
But what if those small players fold because it’s not profitable to make a widget that costs $1 for 20 cents? “In a crisis situation, players with small operations can shut down their factories overnight. The owners take the easiest exit by just fleeing without paying workers their accrued wages. I have seen many situations like this in the past two-to-three years, and I believe I will keep seeing this for the next few years,” said Lee.
There’s reason to be worried: business isn’t what it once was. Although his company’s production capacity has increased post-crisis, the plush toy manufacturing industry as a whole has seen total production capacity fall by 30%.
Of course, business could improve dramatically if Dream International were to sell more toys within China. The firm has been operating there for four years, mainly through hypermarkets, which are the main source of business for its ODM business. However, the firm has not made a single penny of profit in this market, said Lee. This is simply because each hypermarket is individually operated, and if store managers decide not to display a certain product, then they take advantage of Dream International’s “no questions asked, 100% return policy” if no sales are made. He says that one of the hypermarkets has been returning 15% of even their best-selling products. And yet he perseveres.
“There is too much administrative effort for us to deal directly with retailers in China for very low sales volumes,” said Lee. “We are waiting for a proper marketing channel to be established in China. There is major potential in the China market, especially in the eastern coastal areas, when this happens. So despite only making a loss, we are keeping our business operations running in China.”
It’s a dangerous gamble — waiting on the market to develop. But its allure is unparalleled.
This story was first published in the November 2010 issue of FinanceAsia.
