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Overheard and Observed in China: Part 1: The Economy

I just returned from a way-too-short and rapid trip to China. There are so many angles and facets to explore but for a Part 1, I thought I’d focus on some interesting economic dynamics in China that are highly interrelated with some equally interesting dynamics in the U.S. economy.

As context, note that the overarching paradox of trading with China from a U.S. standpoint is (a) we like China’s cheap costs but (b) we don’t like the trade gap. The burgeoning trade gap is particularly bothersome as the U.S. dollar continues to free fall in the international currency markets, which should make buying U.S. products more attractive than ever. But the trade deficet is going to be a side light and what U.S. businesses and consumers are really going to notice in the near and foreseeable future is that costs in China are on the raise and may increase at a more rapid pace. Here’s why:

1. We’re not the only ones that dislike a huge trade gap; for China’s economy to mature, more of its output needs to be consumed internally, not just by the export market. Toward that end, in the last ninety days Beijing has rescinded a substantial tax rebate (think subsidy) for factories and business that export their goods. That will no longer be part of the formula for quoting costs to U.S. companies that outsource to China.

2. The RMB (China’s currency) is up 20% against the U.S. dollar in the last 18 months. The renmimbi (“people’s currency”) is stronger across against many currencies on the international board, but with the ongoing storyline of a still declining U.S. dollar and its spending power, the bottom line result is higher costs.

3. New labor laws in China include new increases to the minimum wage and a sweeping worker reform act–no company can fire a worker once they sign a third employment contract–equals raising labor costs. On the second element, the reform act, one wonders if most Chinese laborers will now end up working for a new company every four years as many labor contracts are two year deals. Not even an almost limitless labor pool can hold back the simple reality that conditions for workers–from wages to safe working conditions to better factory-owned dormitories or private housing options–have improved and must continue to improve. Some have argued that with the reported 750 million unemployed workers this need not be the case. But what has changed is that people living a subsistance lifestyle in the great rural expanses of China are no longer willing to trade an open air work day for a factory work day that is still based on mere subsistance worker benefits.

4. Rising materials costs are happening across most industry categories, led by rocketing oil prices, but in my world, publishing, it comes as no surprise that the cost of paper keeps marching upward at a particularly steep grade. U.S. standards of “green” are much less stringent than those defined in Europe, but as that gap closes, costs will only continue to climb. Related but off topic: Bill Gates said that we tend to overestimate the impact of new technology over the next two years but underestimate its impact over the next five years (see Business at the Speed of Thought). I wonder: will there be a stampede to ebook readers in the next half decade?

5. When you add up nos. 1-4, not surprising but largely unnoticed in the business community, hundreds of Chinese factories are closing every month. Profit margins and Return on Investment (ROI) are so slim that the Chinese entrepreneurial class is looking for new and greener opportunities. Marching alongside the issue of ROI , the first true generation of entrepreneurs in China is hitting retirement age and the heirs don’t want to run factories–or in some cases can’t afford to run existing operations–so they’re selling off equipment and boarding up buildings. Some argue that this is simple Economic Darwinism and is a positive case of natural selection with inefficient operations falling by the wayside. Perhaps; but it should not come as a shock that as once or emerging third world economies develop, they no longer take on environmentally toxic projects with no questions asked.

Two questions that I predict will become more acute for U.S. (and world) companies that do manufacturing in China in the days ahead will be: are we anticipating and ready for continued rising costs? and are the vendors we are currently relying on going to be in business for the foreseeable future?
Stay tuned for Part 2 of things I observed and overheard in China …

Sales Continue to Drop for Print Books

Publisher’s Weekly just reported:

The total unit sales of print books sold through the outlets whose sales are captured by Nielsen BookScan dropped 10.2% in the six month period ended July 3, falling to 307.1 million. Among categories, the biggest decline came in adult fiction with units off 25.7%, while mass market paperback had the steepest decline among formats with units down 26.6% in the period. BookScan totals cover about 75% of the outlets where print books are sold.

Is this yet another signal that the book is dead or should at least be placed on the endangered species list?

As someone who makes a living in the book publishing industry I continue to maintain an optimistic position on the future of the book, in part, because I don’t define the book as a physical object.

I see no reason for hand wringing. Publishers need to keep their focus on what they can control and what matters most: great content. The distribution medium matters but is not paramount. The music industry fought Napster (rightfully) and electronic distribution (wrongly) for most of a decade – and lost control of its own packaging and pricing. I think the book publishing industry has maintained a much healthier point of view toward electronic formats from day one.

I like physical books – actually, love is the better word for it – but I’m not going to lose sleep if we sell more books as electronic editions and kill fewer trees in the process. One of the biggest benefits of selling e-books for publishers is fewer dollars tied up in paper and ink with all the inventory management issues surrounding that. The amount of time it takes to recoup a dollar of the investment that goes into publishing a book is long enough without making the irreversible commitment to a print quantity that may not dovetail with real demand.

Of course many publishers have long built financial models around a certain percentage of their unit sales coming from higher priced hard cover releases. As e-books continue to eat into the number of hardcovers sold, particularly with adult fiction, it changes the proforma dramatically, so I’m not saying this change makes things easier in all ways. Change is hard.

I’m strictly describing what I think is – not proscribing what should be. And no matter how strong Amazon is as a bookseller, I still hope the market will support a robust brick and mortar retail environment. (Borders might not agree that is possible – but we should know if their reorganization is Chapter 11 or Chapter 7 within days – or even hours.)

My personal prediction – more gut than numbers at this point – is that five years from now 35-40% of all books sold will be e-books (digitally distributed), which would mean the majority of books consumed would still be on the ink and paper medium. I also think that projection would leave space for a strong brick and mortar presence for at least Barnes and Noble and some exceptional independents that incorporate an e-book strategy into their overall sales mix.

“The reports of my death are greatly exaggerated,” said Mark Twain after hearing his obituary had been printed in the New York Journal.

The same can be said by and of the book.

Overheard and Observed in China: Part 3: Odds and Ends

Time to move on to topics I’m less ignorant on, but after one more quick glance at my pictures and journal from China, I thought I’d throw a few odds and ends for your consideration.

1. Just a few miles from Hong Kong, part of the same country but a full border crossing away, stands Shenzhen. A fishing port of 300 thousand, it was singled out by Deng Xiaoping in 1979 as China’s first Special Economic Zone. Since then, 30 billion (U.S.) has flowed into the city and the population has grown to more than 10 million residents–with commuters and “invisible” people” causing estimates to fluctuate up to as many as 15 million)–and still growing. It is the most densely populated area of China. And you thought overcrowding was a problem in your city?

2. The level of “deferentialism” extended to American and other foreign business visitors to China is almost overwhelming. It’s hard to carry your own briefcase from the car to the meeting area without a young lady who probably doesn’t weigh 90 pounds wanting to lug it for you. We all like to be treated with courtesy and respect–and much more so when we are in a new environment–but the amount of attention given to helping one with their every move can create feelings of guilt. I’m over the guilt, however, so I’m not complaining–just observing!

3. In Shanghai, I’m pretty sure there is a ratio of one billboard for every resident–and visitor. And maybe for each panda, too!

4. Speaking of billboards, I was surprised that most of the signage in Hong Kong depicted Western models. The rule of thumb in advertising is that you strive for cultural relevance. I do have one idea on why the city’s signage looked a lot like New York City’s. Since Brand America is still the icon of wealth and prosperity, ad agencies in Hong Kong have played the “aspirational” card to the hilt. Of course, if the U.S. dollar drops any further, there may be job openings for billboard hangers in the near future!

5. China has long been viewed as a homogeneous people, which has probably always been a myth. If you look a the under-20 fashion statements even on the Mainland, China is rapidly becoming a diverse country.

6. I had dinner at the Peninsula Hotel in Hong Kong. A fleet of about 15 Rolls Royce Silver Shadows are arrayed in front to whisk guests to shopping and tourist destinations. I still haven’t figured out why my company’s travel manager didn’t book me there.

7. I talked to several business people there and in route who have a very strong non-financial motivation to doing business in China. It goes like this. China is not open to Christian missionary work. China is very open to Christian business men and women (and teachers). Once in China, there is plenty of freedom for religious expression (more so for foreigners but increasingly for the entire population as long as the topic isn’t Thailand or Tibet) combined with a keen interest in people from other countries, with America at or near the top of the list. Who knows how many “tent makers” are doing a good work in sharing their faith in China.

Q: How Well Do Publishers and Booksellers Work Together?

A: Publishers and retailers work together well in some areas – but there is a huge disconnect based on competing self-interests that make it difficult to help each other succeed.

What makes for a successful retailer? More revenue than expenses, of course, but not just a simple profit and loss reckoning, but profitability within a biz model that includes a positive monthly cash flow. Healthy cash flow is achieved through healthy inventory turns. What are turns? For a bookstore that mean ordering copies of a title on payment terms (often 60- and more often 90-days to pay) and then hopefully selling those copies and getting money for them at the cash register before writing a check to the publisher.

How likely is that to happen if you are stocking 200 thousand inventory items in a big box national chain? Not likely. But hot selling titles will hopefully push overall performance numbers up. But what happens if there’s no new Harry Potter or vampire title to average in with the laggers (and even help them move more briskly because of increased consumer traffic) on the aggregate? What if you are a retailer and your inventory piles up to the point that you don’t have the funds to buy new books (referred to as ‘open to buy dollars’)? Simple. You return slow-moving titles, of course.

Store buyers place their orders with publishers (and/or distributors) based on projections of how many copies of a book his or her stores will sell in the first four to six weeks. How does the buyer come up with those projections? He listens to the publisher’s sales rep give the key selling points, comparable titles, and publicity plans. He then combines the sales rep’s projections with what his reports on the comps and his own gut tells him, and then places his order a couple weeks or months later. With the large chains the buyer will get a personal report card based on how well his titles met those projections. He has the further accountability of a finite dollar number in his corporate check book. Once that number nears zero without being replenished, his ‘open to buy dollars’ are done. So not only will he return books if they are not coming close to meeting forecasts, but he may be forced to return some borderline performing titles in order to have more dollars available to purchase a hot-selling title. To the publisher this feels like the retailer is paying his bills with returns.

The preceding paragraph sums up what is in a book retailer’s best interests – and what their challenges are. What about the publisher?

A publisher feels like she will do well on a single title when she adds up pre-press expenses (cover and interior design and editing), manufacturing expenses, direct marketing expense, overhead, a return reserve (usually an aggregate percentage applied to each title that assumes not every copy printed will actually sell and will have to be disposed of as an overstock or remainer), and royalty expenses (including advance against royalties), and then subtracts that number from sales projections – usually three-month, six-month, and 12-month projections. How does she come up with those projections? She reviews the performance of comparable titles and considers the author’s ability to help promote sales of the title to come up with her own number. She then shares her thinking with sales and marketing teams who will listen and agree or disagree in some measure and come up with their own projections. Different companies settle those differences in different ways. The publisher will do well on a single title in reality when the retail buyer brings in the number of titles projected (sell-in) and consumers buy enough copies of that title off the shelf (sell-through) to generate reorders. The publisher will get her report card on the basis of meeting or exceeding the original projections. She will do particularly well when overall sales pay off any advance against royalties and re-orders are frequent enough to keep inventory levels down (books sitting in a warehouse are like bananas – they can go bad overnite!).

The common success denominator for retailers and publishers is managing inventory levels. The retailer tries not to over order in the first place and is quick to return laggers. Both dynamics hurt the publisher who saves money on higher press runs and gets killed by returns. When publisher and retailer both get too conservative in order to combat this, another negative occurs. Stock outs. What happens when a customer comes to the store and the book he is looking for isn’t there? He forgets about it – or if he is persistent, he orders it online and waits for it. That kills brick and mortar retailers. Another less obvious impact of conservative buying patterns is the lack of merchandising. There was a day when you would walk into a bookstore and there would be numerous titles stacked high to capture attention and send the message that this was a book that just had to be purchased. With a few notable exceptions, like the afore-mentioned Harry Potter example, title emphasis is more subtle – and much easier to miss (or ignore).

Two relatively recent technological developments that are helping publishers more than brick and mortar retailers are print-on-demand and the e-book. Print-on-demand vendors provide a pretty high quality book (and the print quality is getting better all the time) – though without bells and whistles like foil and embossing – overnight and at a reasonable price. Not as good a price as printing 100 thousand books on an offset press, but a good enough price that beats the heck out of an excess inventory fall bonfire! An e-book is never out of print. Add those two dynamics together and any book is technically available within 24-hours to a retailer or individual consumer without the risk of large print runs.

But back to the publisher-retailer relationship. Even print-on-demand can’t totally mitigate the damage to performance numbers that occurs because the two parties have conflicting interests when it comes to inventory management.
Is there a solution? If you follow the financial reports of major publishers and retailers, neither side of the equation is doing well enough to give much in the give and take of business.

The solution for the author who wonders why his or her book isn’t selling like it should is to look in the mirror and ask him or herself what he or she can do to build demand. The book publishing and selling environment isn’t currently emulating the Fields of Dreams. Just because you wrote it doesn’t mean it will sell.