• Our latest survey revealed that among mainland-origin exports managed by Hong Kong, offshore trade made up 56% of the total export value of the respondents in 2006, compared to just 18% in 1988.
  
  
• Not surprisingly, lower transportation costs are the major reason for direct shipment, as the mainland's port facilities continue to expand and improve.
  
  
• The reasons for Hong Kong companies choosing to re-export their goods through Hong Kong are mainly related to the quality of service, such as convenient shipping schedules and ability in cargo consolidation.
  
  
• Despite signs that Hong Kong's role as a logistic hub is diminishing, Hong Kong companies will still use Hong Kong as an operation centre for the coordination and management of their businesses.
  
  
• In particular, 47% of the respondents expected their sales and marketing functions in Hong Kong will increase.

Since the 1980s, Hong Kong manufacturers have been shifting their production and trade-related activities across the boundary for lower production costs. According to our latest survey, 91% of the respondents had manufacturing bases and sourcing origins on the mainland in 2006, 26% in Hong Kong, while 28% in other regions.

In tandem with the expansion and improvement in China's port facilities, there has been a rising trend of Hong Kong manufacturers shipping their goods to overseas markets directly from the mainland or transhipping via Hong Kong (referred to as offshore trade). In this survey, it was found that among mainland-origin exports managed by Hong Kong, offshore trade made up 56% of the total export value of mainland goods of the respondents in 2006, compared to just 18% in 1988.

When asked why direct shipment was preferred, 66% of the respondents gave "lower transportation costs" as their reason, followed by "buyers' request" (50%) and "factories far away from Hong Kong" (33%). Compared to the survey result in 2003, there were more respondents saying that buyers' request and shorter delivery time were the reasons why they chose direct shipment in 2006.

On the other hand, the reasons for Hong Kong companies choosing to re-export their goods through Hong Kong are mainly related to the quality of service. In 2006, the main advantages of using Hong Kong's port facilities were "convenient shipping schedules" (44% of total respondents), "able to handle shipments requiring consolidation efficiently" (44%), "buyers' request/confidence in the performance of Hong Kong's port facility" (35%) and "greater choice of routes" (34%). But comparing the results of 2006 with those of 2003, declines were seen in the percentages of respondents for almost all the reasons for re-exporting China-made goods through Hong Kong.

After all, the decision on shipping arrangements depends on a combination of several factors, including price, safety, time, speed, schedules, types of goods, standard of service and supporting facilities. For goods with high value such as electronic components or jewellery, transportation costs may be of little concern to shippers compared with the risk of delay or loss. In such a case, shipment by air using Hong Kong's airport may be preferred.

Today, the mainland is not only important as a production hinterland; it has great potential to be one of the largest consumer markets in the world. Our survey revealed that Hong Kong companies have been aware of the great potential on the mainland. In 2006, there were 25% of the respondents selling goods to the mainland, and more than half of those not selling there had plans to do so in the next three years.

Amid expanding sales to the mainland, there are increasing challenges for Hong Kong companies in their PRD production. 44% of our surveyed companies had production base in the PRD in 2006. They identified rising labour costs / lack of skilled labour the major problem of manufacturing in the PRD. Besides, renminbi appreciation and rising land costs / restrictions on land use were also concerns. To tackle the problems, most of them said they would improve their products. Still, 37% said they would relocate all or some of their existing production from the PRD to other regions.

The rising trend of offshore trade, along with the plans of some companies to relocate all or part of their existing production from the PRD to other regions, seems to suggest that the role of Hong Kong as a logistic hub has been diminishing. Still, 43% of our surveyed Hong Kong companies said their air shipments via Hong Kong would not change, and around one-third would maintain their sea shipments, warehousing and cargo consolidation in Hong Kong. Over 10% of the respondents will even increase their cargo shipments via Hong Kong, and expand other logistic-related activities here.

Our survey confirmed that many Hong Kong companies will still use their Hong Kong office as an operation centre for the coordination and management of their businesses, and Hong Kong's role as a provider of high-quality trade-supporting service would not diminish. There were more respondents saying that their overall management and planning, finance and accounting, product design and development, sales and marketing, quality control, and trade financing / insurance arrangement of their Hong Kong office will increase than those who expected decreases. In particular, 47% of the respondents expected their sales and marketing functions in Hong Kong will increase.

I. Background and Methodology

Hong Kong companies have long been manufacturing and sourcing on the Chinese mainland, especially the Pearl River Delta region (PRD), with some 58,000 Hong Kong-funded factories operating there. Although the mainland is the principal manufacturing and sourcing base of Hong Kong companies, China-made goods do not necessarily come first to Hong Kong then to overseas markets. They can be transhipped through Hong Kong or simply shipped directly to overseas. Exports by these arrangements are not reflected in Hong Kong's trade statistics, and are referred to as offshore trade.

Being a manufacturing and sourcing hinterland aside, the mainland is also a domestic market for Hong Kong companies. The Chinese economy has seen brilliant economic growth in recent years. With rapid urbanisation, rising incomes and the government's intention to shift the economy to domestic demand-led growth from export-led growth, huge opportunities exist in the mainland market, in which Hong Kong companies are certainly interested.

While expanding sales on the mainland is a challenge facing Hong Kong companies, there are also increasing operational difficulties, notably cost escalations and changes in processing trade policies. In order to better understand these latest developments and keep track of the trend of offshore trade, the Hong Kong Trade Development Council has initiated a large-scale triennial survey for 2006, the seventh of its kind since 1988. This report presents the major findings from our latest survey.

1. Methodology

The survey for 2006 was conducted in the first quarter of 2007 using the same methodology as in the previous exercises. Questionnaires were sent to local manufacturers and exporters in HKTDC's database. Questionnaires completed and returned were processed by HKTDC staff verifying the completeness and consistency of the information supplied. Respondents were contacted for follow-up questions if necessary. Valid replies were duly input into the computer for analysis. Questions on the development of offshore trade were the same as before to ensure continuity and meaningful comparison with previous surveys.

2. Profile of Respondents

A total of 3,983 valid replies were received, with 52% from traders, 29% from manufacturers, 14% from manufacturers-cum-traders, and the remaining 5% from others, including buyers, agents, agencies, wholesalers and retailers. Respondents are engaged in a wide spectrum of activities, with most of them in light industries, such as electronics, giftware/premiums, garments, textiles, plastic products, toys, jewellery and watches/clocks.

The majority of respondents are small and medium-sized enterprises (SMEs). This pretty much corresponds to the structure of manufacturers and traders in Hong Kong. In terms of export amounts in 2006, 55% of the respondents handled goods worth less than HK$10 million, 37% between HK$10 million and HK$100 million, and the remaining 8% over HK$100 million.

II. Current Status of Offshore Trade

Since the 1980s, Hong Kong manufacturers have been shifting their production and trade-related activities across the boundary for lower production costs. At that time, China's port facilities were unable to cope with large volumes of export and thus goods manufactured or sourced by Hong Kong companies on the mainland had to be exported to overseas markets via Hong Kong. This led to a boom in Hong Kong's re-export trade. By 1988, Hong Kong's re-exports had already overtaken domestic exports (i.e. export of goods manufactured in Hong Kong) in terms of dollar value.

Throughout the years, the scale of production on the mainland has expanded and China's port facilities have improved. As a result, there has been a rising trend of Hong Kong manufacturers shipping their goods to overseas market directly from the mainland without touching Hong Kong.

1. Manufacturing Base and Sourcing Origin of Hong Kong Companies

The export products handled by the respondents come from different origins, with the Chinese mainland remaining the major manufacturing base and sourcing origin. In 2006, 91% of the respondents said they had manufacturing bases and sourcing origins including the mainland (vis-à-vis 90% in 2003), 26% including Hong Kong, while 28% including other regions.

The Chinese mainland, especially the PRD, has remained the principal manufacturing base and purchasing source for Hong Kong companies for decades. This is because the PRD is close to Hong Kong and its industry and supporting facilities are mature. According to the survey findings, among respondents exporting China-made goods, 59% have their goods produced in Guangdong only, 31% in both Guangdong and other parts of the mainland, and only 11% outside Guangdong.

Although this 59% of respondents having all their exports originating from Guangdong in 2006 dropped slightly from 61% in 2003 and 70% in 2000, this does not mean Hong Kong companies have given up Guangdong as the manufacturing base and sourcing origin. In fact, they have extended their production and sourcing base to other parts of China, i.e. producing and sourcing in both Guangdong and other parts in China. The percentage of these respondents rose to 31% in 2006, compared with 28% in 2003 and 17% in 2000.

Outside Guangdong, the Yangtze River Delta (YRD, which includes Shanghai, Zhejiang and Jiangsu) is another major manufacturing/sourcing base for Hong Kong companies, with 29% of the respondents indicating that they had goods made in the YRD, 12% in the Bohai region (including Beijing, Tianjin, Liaoning, Shandong and Hebei), and 16% in the pan-PRD region outside Guangdong. The results for 2006 are similar to those for 2003.

2. Export Situation by Place of Origin

As shown above, China is the principal manufacturing base and purchasing source for Hong Kong companies and such a role has become more and more important. The same conclusion can be drawn from the total export value of Hong Kong. In 2006, of all the export goods of the respondents, 74% were made on the mainland, slightly above the 73% for 2003 and much higher than the 36% for 1988, whereas Hong Kong products only accounted for 6%. Yet the share of Hong Kong products did rebound somewhat in 2006, reversing the decreasing trend since 1988. We believe the Closer Economic Partnership Arrangement (CEPA) between Hong Kong and the Chinese mainland, introduced in 2003, may have successfully encouraged some products to be manufactured in Hong Kong. Under CEPA, goods of Hong Kong origin importing into the mainland can enjoy tariff free treatment upon applications by local manufacturers and upon the CEPA rules of origin being agreed and met.

Not surprisingly, China-made products make up a large proportion of most light consumer goods sectors. In 2006, those sectors with over 80% of China-made goods included toys (95%), footwear (93%), giftware/premiums (91%), stationery/office supplies (90%), decorations and craft (90%), printed matters/packaging materials (89%), electrical appliances (89%), plastic products (88%), travel goods/handbags (88%), computer/telecom products (86%), household products (non-electrical) (86%), garments (83%), hardware (80%) and textiles (80%).

Hong Kong-made goods, on the other hand, are mostly higher-end products. A relatively higher percentage of raw materials, metal and commodity (15%), textiles (11%), jewellery (9%) and garments (7%) were made in Hong Kong in 2006. Although production costs are significantly lower on the Chinese mainland, which is just across the boundary, the rationale of locating production activities is obviously beyond cost consideration. Apart from the positive effects of CEPA, some Hong Kong companies maintain local production to bypass quotas or other overseas restrictions against the mainland, while some others may just look for higher quality or have to meet tight delivery schedules.

Regions outside the mainland mainly supply raw materials, semi-manufactures, parts and components, and machinery: chemicals (65%), electronic parts and components (49%) and machinery (47%).

3. Shipping Arrangements for Hong Kong Exports

Exports by Hong Kong companies take the following four shipment methods: 1) domestic export; 2) re-export through Hong Kong; 3) transhipment via Hong Kong with through-bill-of-lading; and 4) direct shipment from place of origin. Domestic export applies to Hong Kong-origin goods, whereas the other three apply to goods made outside Hong Kong. Transhipment and direct shipment are referred to as offshore trade. In the statistics of the HKSAR Census and Statistics Department, domestic exports and re-exports are classified under merchandise trade, while offshore trade is put under service trade and GDP.

As exporting Hong Kong-made goods will only be regarded as domestic exports, we shall focus on the shipping arrangements for goods made in China and those outside Hong Kong and China. Where the goods are produced will affect the choice of shipping arrangements.

a) Exports of Goods Made in China

Our previous surveys showed that most goods made in China were shipped overseas by re-export through Hong Kong. Back in 1988, 82% of goods made in China were re-exported through Hong Kong, whereas only 18% were transhipped via Hong Kong or directly shipped overseas. However, the proportion of re-exports through Hong Kong has declined throughout the years, and those shares are taken up by direct shipments. In 2006, only 44% of goods made in China were re-exported through Hong Kong, while the proportion of offshore trade, comprising both transhipments and direct shipments, stood at around 56%.

As noted, the sum of direct shipment and transhipment via Hong Kong is referred to as offshore trade. In other words, the proportion of offshore trade of China origin has grown substantially from 18% in 1988 to 56% in 2006, indicating that the size of offshore trade has surpassed the value of re-exports. But in absolute terms, the value of re-export of China-made goods has not dropped. According to the HKSAR Census and Statistics Department, Hong Kong's re-exports of China-origin grew from HK$132bn in 1988 to HK$1,461bn in 2006.

By sector, higher-valued items, such as jewellery (86%), electronic parts and components (77%), watches and clocks (68%) and computers/telecom products (64%), were mostly re-exported through Hong Kong in 2006. These goods are high in value, small in size and light in weight, and that is why shipment by air is justified. Given the efficiency of Hong Kong International Airport, the advantages of re-exporting through Hong Kong are obvious. On the other hand, bulk merchandise such as chemicals (82%), footwear (81%), food and beverages (73%), machinery (72%) and household products (non-electrical) (71%) were mostly exported by direct shipments.

When asked why direct shipment was preferred, 66% of the respondents gave "lower transportation cost" as their reason, followed by "buyers' request" (50%) and "factories far away from Hong Kong" (33%), suggesting that transportation costs are the most important reason for choosing direct shipment. The results are quite similar to that in the 2003 survey, but in 2006 there were more respondents saying that "buyers' request" and "shorter delivery time" were the reasons why they chose direct shipment, and fewer of them stated "factories far away from Hong Kong" to be the reason.

Reasons for Hong Kong companies choosing to re-export their goods through Hong Kong, however, are more related to the quality of service. According to this survey in 2006, the main advantages of using Hong Kong's port facilities were "convenient shipping schedules" (44%), "able to handle shipments requiring consolidation efficiently" (44%), "buyers' request/confidence in the performance of Hong Kong's port facility" (35%) and "greater choice of routes" (34%). But comparing the results of 2006 with those of 2003, declines were seen in the percentages of respondents for almost all the reasons for re-exporting China-made goods through Hong Kong.

After all, the decision on shipping arrangements depends on a combination of several factors, including price, safety, time, speed, schedules, types of goods, standard of service and supporting facilities. For goods with high value such as electronic components or jewellery, transportation costs may be of little concern to shippers compared with the risk of delay or loss. In such a case, shipment by air using Hong Kong's airport may be preferred.

b) Exports of Goods Made Outside Hong Kong or the Mainland

Goods made outside Hong Kong or the mainland are mainly exported by direct shipment, but there was a rebound of re-exports through Hong Kong in percentage terms. The proportion of direct shipments had steadily increased throughout the years to 63% in 2003, and dropped back to 55% in 2006.

Industry-wise, a large proportion of food and beverages (85%), jewellery (85%), watches/clocks (70%), chemicals (62%) and electronic parts and components (56%) were re-exported through Hong Kong in 2006. Goods produced outside Hong Kong and the mainland, but re-exported through Hong Kong, are likely destined for the mainland. Revitalisation of re-exports via Hong Kong obviously reflects the rising demand from the mainland for a number of imported consumer goods spanning from jewellery and timepieces to medicinal products and electronic parts and components. In particular, food and beverages are perishable, while others are light in weight and high in value. Thus, these goods are usually re-exported through Hong Kong by air to utilise Hong Kong's well-recognised air transportation service.

4. Estimates for Domestic Exports, Re-Exports and Offshore Trade

Based on the findings of this survey, we estimate that the domestic exports, re-exports and offshore trade of the respondents accounted for 7%, 43% and 51% of their total export value respectively in 2006. In fact, in 2003, the value of offshore trade handled by the respondents has already exceeded that of their re-exports, or equivalent to 112% of the latter. In 2006, the proportion further increased to 119%.

III. Selling to the Mainland

In the past, Hong Kong companies exported most of their goods produced on the mainland to overseas. Today, everybody would agree that the Chinese mainland is not only important as a production hinterland; it has great potential to be one of the largest consumer markets in the world, given its brilliant economic growth in recent years plus the large population. A significant proportion of Hong Kong's offshore trade is indeed destined for the mainland market.

According to our survey, 25% of the respondents revealed that they sold goods then on the mainland. The result for 2006, slightly lower than those in 2000 and 2003, may reflect some consolidation amid the challenging business environment. This, however, does not mean that Hong Kong companies have lost interest in the mainland market. Those who have not sold goods in the mainland have indicated a strong intention to do so. In 2006, more than half of those did not sell to the mainland but planned to do so in the next three years, higher than that in 2003 by more than 10 percentage points.

It was found that capital goods had higher ratios of currently selling to the mainland in 2006: chemicals (52%), machinery (52%), electronic parts and components (42%), and raw materials and metals (42%). Consumer goods, by contrast, had lower ratios - toys (11%), decorations and craft (12%), giftware/premiums (13%), watches/clocks (14%), although those for clothing and related goods are relatively higher - garments (18%), footwear (20%) and textiles (24%). These results echo the mainland's sustained appetite for capital goods, but a comparatively modest demand for consumer goods, despite the continued uptrend in recent years.

Not surprisingly, raw materials, parts, components, and semi-manufactures constitute more than half of the goods sold to the mainland by Hong Kong companies. The share decreased slightly to 54% in 2006, from 55% in 2003. The share of machinery has also fallen to 9% in 2006, from 13% in 2003. What respondents sold more of in 2006 were consumer or finished products, with the share increasing to 37% from 31% in 2003.

In terms of origin of goods, the majority of goods of Hong Kong companies sold to the mainland market mainly come from both the mainland as well as places other than the mainland and Hong Kong, which accounted for 42% and 43% respectively in 2006. Meanwhile, the share of Hong Kong-made goods was 15%, relatively high given the limited manufacturing activities in Hong Kong, facilitated by the implementation of CEPA. In the next three years, respondents expect to sell more mainland-made goods, with their share rising further to 45%.

While the percentage of respondents selling to the mainland dropped in 2006, the total sales of our respondents in the mainland increased in general, with rises in the percentages of those with higher sales. The share of respondents with sales below HK$1 million in 2006 decreased to 25% from 28% in 2003. Yet for those with sales between HK$1 million and HK$5 million, the share was 29%, up from 28% in 2003; for those with sales above HK$5 million to HK$10 million, the share increased to 14% in 2006 from 12% in 2003; and the shares of respondents with sales above HK$10 million were about the same in 2003 and 2006.

Looking ahead, although there were just 25% of our surveyed Hong Kong companies selling to the mainland in 2006, the majority of them were confident in their sales prospects. Among those respondents already selling goods to the mainland, 14% and 60% expected "strong increase" and "modest increase" respectively in the next three years (2007-2009), and only 12% anticipated a decrease in sales. Sectors most optimistic about sales to the mainland are food and beverages, with 94% of respondents expecting their sales to increase in the next three years, followed by computers/telecom products (90%), watches/clocks (89%), plastic products (85%), printed matters/packaging materials (85%) and stationery/office supplies (84%).

IV. Problems of Manufacturing in the PRD

While the mainland has increasingly become a market for Hong Kong companies, it remains by far the most important production hinterland for Hong Kong manufacturers. Since the 1980s, Hong Kong companies have set up their production base on the mainland, mostly in the PRD. In recent years, the business environment in the PRD has been increasingly challenging, amid the central government's policy to upgrade the industrial structure, tighter environmental requirements, as well as soaring production costs.

Survey results showed that 44% of the responding companies had a production base in the PRD. They identified rising labour costs / lack of skilled labour as the major problems in manufacturing in the PRD, trailed by renminbi appreciation, rising land costs / restrictions on land use, tightening policies on outward processing trade, and expected tightening of labour contract law.

When asked what strategies they would take to tackle these problems, most of them said they would improve their products. 53% said they would develop better quality products, while 45% said they would enhance product design and innovation. Still, 37% said they would relocate all or some of their existing production from the PRD to other regions, apart from other strategies to increase their added value and strengthen supply chain management.

Among the respondents with a relocation plan, 37% said they would move their existing production in the PRD to pan-PRD provinces other than Guangdong, 34% to other Guangdong areas outside the PRD, 21% to YRD and 6% to rest of the mainland. The remaining 3% even considered to move outside the mainland.

V. Impact of Relocation on Hong Kong

It is generally expected that given their relocation plans, alongside the continued trend of offshore trade, Hong Kong companies will scale down their operations in the PRD, raising concerns over whether the role of Hong Kong will diminish. It is true that most of our respondents said their sea and air cargo shipments via Hong Kong would decrease, while warehousing and consolidation of goods in Hong Kong would also reduce. Interestingly enough, 43% of our surveyed Hong Kong companies said their air shipments via Hong Kong would not change, and around one-third would maintain their sea shipments, warehousing and cargo consolidation in Hong Kong. Over 10% of the respondents would even increase their cargo shipments via Hong Kong, and expand other logistic-related activities here.

The reason for such a still-positive response is that despite relocation out of the PRD, businesses of the respondents, whether they will relocate outside the PRD or not, will continue to grow at a pace able to compensate for the loss in shipments via Hong Kong and the fall in other activities in Hong Kong from relocation.

Our survey results further confirmed that many Hong Kong companies will still use their Hong Kong office as an operation centre for the coordination and management of their businesses, and Hong Kong's role as a provider of high-quality trade-supporting service will not diminish. There were more respondents saying that their overall management and planning, finance and accounting, product design and development, sales and marketing, quality control, and trade financing / insurance arrangement of their Hong Kong office would increase than those who expected decreases. In particular, 47% of the respondents expected their sales and marketing functions in Hong Kong would increase.

A similar conclusion is drawn on the change of staff employment, with more respondents saying that they would increase the number of staff in Hong Kong to perform the above-mentioned functions. It can be seen that in spite of some relocation, Hong Kong companies will still develop their business in Hong Kong, especially high-value trade-supporting services, although it poses a threat to more labour-intensive and low value-added supporting services.

Below we compare the expected change in overall level of activities in Hong Kong in the next three years of three groups of companies - companies planning to relocate their existing productions out of the PRD, companies with PRD production but no plan to relocate their existing production, and companies without PRD production.

Overall, some 80% of our respondents expected to increase or maintain their level of activities in Hong Kong in the next three years. Many of those with no production in PRD expected to expand or maintain their level of activities in Hong Kong in the next three years (85%), while the percentage of those with no plan to relocate existing production in the PRD to other regions was lower at 79%. Even for companies planning to relocate their existing production out of the PRD, 67% expected to increase or maintain the overall level of activities in Hong Kong in the next three years.

In terms of staff employment, the findings are even more encouraging. There were some 88% of the responding companies saying that they expected to increase or maintain their headcounts in Hong Kong in the next three years. Consistent with their expected level of activities in Hong Kong, companies with no production in PRD have the highest percentage of increasing or maintaining their level of staff employment in Hong Kong in the next three years (91%), while the percentage for those with no plan to relocate existing production in the PRD to other regions was lower at 87%. Fewer of those planning to relocate their existing production out of the PRD expected to expand or maintain the size of their workforce (76%), but they still accounted for the lion's share within the group.

This new report is available at TDC's Retail Outlets. It can also be purchased through the TDC Bookshop section in the TDC's trade portal: info.hktdc.com.