Chinese Firework Case Analysis

Case Title
The Chinese Fireworks Industry- revised

Date
October 8th 2012

1. Issue identification：
Jerry Yu is considering whether to invest in Liuyang fireworks factory, so he made an evaluation of the Chinese firework industry. Here is a brief identification of the issue:

1.1 History of fireworks:
There is an old-line of the Chinese fireworks, which is tightly combined with varieties of celebrations and festivals in China. Especially, Liuyang is known as “the home of fireworks and firecrackers” and good at making varieties of fireworks. And fireworks and firecrackers has become the pillar industry of Liuyang.

1.2 Product:
Fireworks mainly include two categories: display fireworks and consumer fireworks, which are displayed respectively in large public display shows and consumers’ backyards, with different pyrotechnicians and visual effects. Although the varieties and skill levels of fireworks are increasing, innovation in fireworks-making (e.g. Ingredients, manual processes) is shortcoming.

1.3Industry:
The fireworks and firecrackers industry in china was dominated by small family-owned-and-operated workshops. The problems with it are: lack of skilled worker and engineers with advanced professional training; safety issues and quality problems; lack of product innovation; no consolidation and fierce price competition. Besides, outside and inside environment are becoming severe: growing cost of row material and labor force, intense
competition especially on price, lack of intellectual property protection…

1.4 Market :
The domestic market is large and stable in demand, and the market demand stages is becoming higher, meaning more profit opportunities.

However, many problems exist: cutthroat price competition, legal restrictions on fireworks displays in many cities, local protectionism hard-to-penetrate distribution channels, and receivables and bad debt control. Fortunately, government of Liuyang took out offensive strategy aiming at these issues and made big achievements on market share and attracting foreign investors. The export market has growing dramatically, featured with low price, many varieties, low reputation in quality control, compared to the products of Japan and Korea. Low profit margin, competition, high markup of the importers, the risk of Chinese fireworks makers losing their brand identities are bottlenecks of export. Characteristics of export are: popular in Europe and large in north America, better prices, weak seasonality in demand. Distribution channels are mainly foreign trade companies or agents. 1.5Future:

Pessimistic one: legal restrictions, fierce competition and changes in consumer preference make fireworks a dying industry. And there are more and more fancy, environment friendly substitutes. Optimistic one: tradition would not die so easily, so that there are no real substitutes for fireworks. With modern technology, safety and environment problems can be solved. China’s brand as a world class fireworks producer is on the rise.

2. Situational analysis
2.1 Macro environment
In order to analyze the macro environment, we use the PEST Analysis

2.11 Politics
Regulations of consuming fireworks:
Fireworks become heavily regulate in most countries because of numerous accidents related with fireworks which had resulted in tragic human injuries
and considerable property damages.

For instance, In the United States, multiple government agencies were involved in fireworks-related injuries. Although at the federal level, fireworks and firecrackers were allowed as long as the safety features were up to the standard, local governments would allow only certain kind of fireworks being sold. However, the remaining 40 would allow essentially all consumer fireworks. For display fireworks, permits would have to be obtained from federal and local authorities and fire departments. Moreover, all legal consumer fireworks offered for sale in the United States had been tested for stability by the Bureau of Explosives and approved for transportation by the U.S. Department of Transportation.

The fireworks are all of high- quality, so no special storage was required. Also, in the most Europe, similar regulations were in place for safety considerations, only the requirements were regarded as less stringent. In Canada, regulations were extremely restrictive. However, over the past decade Chinese fireworks companies had made great strides in the Canadian market. As to the domestic market, during the 1990s, increased concerns over environmental pollution and safety of human life and property led more and more cities to regulate he consumption of fireworks and firecrackers. However, all this began to change in the mid-2000s. Beijing lifted a 12-year ban on fireworks in 2005 and other cities followed suit. Over the next ten years, many legal restrictions were lifted. Offensive strategy to increase the sales of fireworks:

Speaking of Liuyang, in 1997, seeing the decline of its fireworks sales, Liuyang Firecrackers and Fireworks Industry Department, the government agency in charge of the overall development of the pillar industry, decided to start an offensive strategy. First, it opened local offices in most of the 29 provinces, major cities and regions to promote Liuyang fireworks. Second, it regulated the prices that Liuyang fireworks companies could quote and sell in export sales. Third, it resorted to a government-to-government relationship in order to secure contracts for large public fireworks displays in each province. The offensive strategy helps to increase the sales of Liuyang fireworks.

2.12 Economics
The economic system of China greatly influenced the manufacturing of fireworks. After 1949, government-run factories replaced the family-owned workshops. After the reform towards a market economy started in 1979, most of the factories were broken up and became family-run units of production again. Since the opening of the Chinese economy in 1979, exporting had become a major market for the Chinese fireworks industry. As one of the most celebrated products out of China, export sales of fireworks had risen dramatically between 1978 and 2009.

2.13 Social
In a staple of Chinese New Year celebrations, weddings, grand openings, births, deaths and other ceremonial occasions, people get used to setting firecrackers and fireworks. Also, the loud reports and burning fires of firecrackers were found to be perfect for frightening off evil spirits and celebrating good news at various occasions. For more than a thousand years, the Chinese had been seeing off past years and welcoming in new ones by firing firecrackers. To conclude, the fireworks and firecrackers are essential to Chinese people. Fireworks made their way first to Arabia in the 7th century, then to Europe sometime in the middle of the 13th century. By the 15th century, fireworks were widely used for religious festivals and public entertainment. In 1777, the United States used fireworks in its first Independence Day celebration, and fireworks have become closely associated with July Fourth celebrations ever since.

2.14 Technical
The fireworks industry was essentially a low-tech, highly labor-intensive industry. In China fireworks industry, the majority of the manufacturing works were regular farmers who had learned how to make fireworks just by watching and following their elders. However, the key processes like installing powder, mixing color ingredients, putting in fuse, were still manually done by skilled workers. Besides, there were hardly any researches and development facilities, nor human and capital resources allocated to R&D in the most fireworks companies. The few resources that were available were all spent on product varieties. Even in Liuyang, out of the 400000 or so people working in the industry, very few were engineers with advanced professional training. In response, the Hunan and other local governments began initiatives aimed at upgrading the traditional fireworks industry. Substantial amounts of money were spent on R&D. The Liuyang Firecrackers and Fireworks Authority reported that they had spent RMB 2,000 million in projects with the Beijing University of Technology and the Nanjing University of Science. Among these initiatives were environmentally friendly fireworks, which used cold flame fireworks technology.

2.2Industry analysis
Here we use Porter’s Five Forces Model analysis:
2.21Suppliers bargaining power
the main raw material are easy to procure, so suppliers bargaining power is not strong. However as the price of raw material rising and the quality problems exist, cooperation with suppliers is necessary. 2.22Buyer bargaining power

Domestic market: The sellers of the industry are relatively smaller scale of enterprises, and the products basically are standardized so that there is basically no switching costs, all these lead to a strong buyer bargaining power. The export market: the strict and ubiquitous regulations on fireworks, Chinese fireworks makers’ losing their brand, the foreign importers were powerful buyers for: they were well informed, able to hire agents who were very familiar with the industry in China and they could deal directly with the factories that were willing to offer lower prices and there is basically no switching costs. 2.23potential new entrants

Entry barriers are low for: the initial requirement for starting a facility was relatively low. Small family-owned-and-operated workshops are ample and flexible in labor force supply. The labor force and manufacture process are relatively inexpensive. 2.24Threat of substitute product

There were already substitutes in china such as laser beams , which were made of safer materials and could produce same visual and sound effects. However, the fireworks can combine the sensual pleasures of visual, audio and
emotional stimuli, so no real substitutes can replace the fireworks. 2.25The rivalry among competing sellers

Domestic market: The competition in the Chinese fireworks industry is fierce with “cutthroat price competition” and “hard-to-penetrate distribution channels” with the entrance of small companies; competition intensified, driving the price, and ultimately the profitability of each company, to the floor. This force drove the rest of the forces and became the initiator or catalyst to the cutthroat competitive industry. The industry rivalry was centered on price competition to offer buyers the best and lowest price no matter the extenuating circumstances that would ensue. The export market: Except for the domestic competitors, there were also threats from Japanese and Korean companies with better quality and packaging and timing control.

2.3 Microenvironment
Here we use “3C” analysis to analyze the microenvironment 2.31Competitor
The firecrackers and fireworks industry in China was dominated by small family-owned-and-operated workshops. The number of small companies intensified competition. The private workshops were flexible and quick in responding to market demand. They did not entail much administrative cost. Compared to government-owned or some collectively-owned factories, they did incur the costs of providing health care, retirement benefits and housing. They usually did not do any product research or design. “Make-believe fireworks” already appeared as substitutes in China. These were made of red plastic tubes strung together like firecrackers with electric bulbs installed inside the tubes. More interesting substitutes were spotted at some wedding in Beijing, where over the balloons to make explosive cracking sounds as well as leave behind red bits and pieces of debris. Also, more and more young couples were getting married in western styles, in a church or a scenic green meadow outdoors, where serene and quiet happiness prevailed over the traditional noisy way of celebrating.

2.32Customer
The target customers of fireworks and firecrackers are residents, companies
and government. Providing products for governments can bring much profits. As people’s income level and living standards kept rising, fancier and pricier fireworks and fireworks were desired over the cheap simple firecrackers.

3. Alternative generation:
There are only three alternative courses of action.
◎Invest in a large scale company that can make display fireworks and sell products both at home and overseas. ◎Invest in small scale workshop that produces only consumer fireworks and focus on domestic ◎Not invest in the fireworks industry.

4. Analysis of alternatives
4.1 Analysis of investment in the fireworks industry:
The tool used to analyze this case is the Threats-Opportunities-Weaknesses-Strengths Matrix.

4.1.1 The analysis of factory focusing on large scale production of display fireworks and foreign trade of its products Strengths:
In Liuyang substantial amounts of money were spent on R&D. The Liuyang Firecrackers and Fireworks Authority reported that they had spent RMB 2,000 million in projects with the Beijing University of Technology and the Nanjing University of Science. Among these initiatives were environmentally friendly fireworks, which used cold flame fireworks technology. With the development of technology and the authority of Chinese fireworks institutes, the fireworks of Liuyang are more novel and promising to attract more consumers. Weaknesses:

The competition of internal industry is quite fierce. Every competitor is eager to squeeze as many profits as they want. In addition, the technology is increasingly advanced, such as laser fireworks, pseudo firecrackers etc..The young generation inclines to choose the brand-new products to make difference. Plus, the brand conscious is decreasing which led to higher risks the companies take. The foreign investors will concentrate on low price and reasonable quality not the brand. Those fireworks brands are not
be valued. Opportunities:

First of all, the increasing trend in exports of China is steady at least in the next few decades. With increasingly interaction of countries, the foreign powerful buyers have easier access to find the Chinese fireworks factories. Besides that, the principles and regulations of fireworks market in China are still out of specification, which leads to a huge potential in the industry. Furthermore, the economy growth and the improvement of living level can also boost the sales among the business, especially in festivals. Above that, the differences among cultures are becoming fewer and fewer, which makes fireworks not a seasonal product. Also this brings a pile of order to the Chinese fireworks factories. Although the danger of fireworks is known by the world, the research showed the specific data that the danger of fireworks is the most harmless compared to swing sets, skateboards, fishing etc.. Threats:

The fireworks industry and the use of fireworks are highly regulated across the globe, which may hamper Jerry Yu’s stepping into foreign market. In the USA, if people want to sell display fireworks, permits would have to be obtained from federal and local authorities and fire departments. The high quality of fireworks is need, increasing the costs of making display firewokes Otherwise, you will fail to pass the standards and regulations for safety consideration of other countries. Also, the profits might be at a very low level caused by many reasons, for example, labor costs, booming small fireworks companies or factories. What’s more, the foreign trade still handled by middlemen or foreign trade companies, which virtually causes more costs. It is suggested that Jerry Yu may develop a system which can contact the foreign inverter directly to make transactions. Although the large scale of fireworks factory have many threats and weakness, the opportunity and its advantages make it profitable to invest in.

4.12 The analysis of workshops focusing on producing consumer fireworks and domestic market Strengths:
The fireworks industry is the traditional industry in Liu Yang. The data of total revenue of Liu Yang fireworks demonstrates that the fireworks industry in Liu Yang covers up to 75% over the country. There is an enormous market for Jerry Yu to explore. The capital to start a small family workshop is low. The technology and skill of the production of the fireworks are still single. The labor is less skilled on majority, so the investor can save a lot of money on labor costs and administration fee is low. Weaknesses:

There are numerous workshops in Liu Yang leading to a fierce competition. The company of Jerry Yu should ask the government to issue the clause of the market regulation of the fireworks industry market to prevent itself from sinking in the fireworks market. What’s more , the small workshops can’t produce display fireworks which need more technology, they will lose a large percentage of the firework market. Opportunities:

It is encouraged by local government to operate private fireworks companies. With the development of the living level in China, people tend to spend much more money in entertaining during festivals or anniversary. One of it is setting fireworks or firecrackers. As a matter of fact, the phenomenon of copycat can hardly be forbidden in a short run, so it is a gold opportunity for Jerry Yu to make the differentiations among the fireworks markets. Threats:

As people’s income level and living standards kept rising, fancier and pricier fireworks and fireworks were desired over the cheap simple firecrackers. Because of the low cost on raw material, the fireworks from small workshops are of poor quality and are less favorable to environment. Therefore, they are less competitive than fireworks from large company. What is more, the copycat brand is booming, which is a huge threat to the companies of brand conscious. Also, those copycat workshops with low quality of fireworks share large market in China. In this way, Jerry Yu had better to build a stable and long cooperation with the suppliers to keep good quality. To sum up, it’s not wise to invest in the small scale company that produces only consumer fireworks.

4.3 The analysis of not invest in the fireworks factory
First of all, although the fireworks industry and the use of fireworks are highly regulated across the globe, in Europe and Canada, where the regulations on fireworks are less stringent, the orders are of large quantities and better price. Even in the USA, which is considered the toughest market because of complex regulations and high competition, the demand of firework is large. Secondly, some people hold the view that fireworks are facing tough competition from substitutes known as “make-believe firecrackers” that are now being used at weddings and grand openings where earlier fireworks were used. However, the fireworks can combine the sensual pleasures of visual, audio and emotional stimuli, so no real substitutes can replace the fireworks.

Also, in recent years there has been a sharp rise in the number of fireworks manufacturers who all produce undifferentiated products and pricing of these products is the sole competitive criteria for the manufacturers. However, things are quiet different in Liuyang. With the development of technology and the authority of Chinese fireworks institutes, the fireworks of Liuyang are more novel and attractive. To conclude, fireworks are here to stay and the industry could grow further even given the current of market conditions like strict regulations, increasing competition because of various factors, the help of government and more investment in research and development makes the industry very unfavorable for investing.

5. Decision criteria
5.1 Whether the ROI of starting a fireworks factory is decent The initial capital requirement for starting a fireworks factory is relatively low. To set up a factory with the necessary equipment for making large display shells would require around RMB1250000. However, setting up a small family work shop making consumer fireworks and firecrackers would require less than RMB 125000. Although the labor costs in the area are increasing, they are still low now. What’ more, the main raw materials for fireworks, which are stable for a long time, are not difficult to procure. The government and company officials from Liuyang and the surrounding areas agreed to regulate the price of fireworks and avoid the cutthroat price competition so that the profit margins in the domestic market can be ensured. The export sales of firework are increasing as well. Considering the domestic market and export market, the ROI of starting a fireworks factory that can produce both the display fireworks and the consumer fireworks is decent.

5.2 Is the market of fireworks broad
In terms of the domestic market, fireworks and firecrackers have long been an integral part of any ceremonies held in China, therefore the demand is stable. In recent years, as people’s income level and living standards keep rising, fancier and pricier fireworks and firecrackers are desired over the cheap simple firecrackers, thereby, creating more profit opportunities for the large fireworks factories. One the other hand, the export market is profitable as well. In Europe and Canada, where the regulations on fireworks are less stringent, the orders are of large quantities and better price. Even in the USA, which is considered the toughest market because of complex regulations and high competition, the demand of firework is large. To sum up, the market of high-quality fireworks is broad.

5.3 Whether there are many obstacles on the way of running a fireworks manufactory It can’t be denied that legal restrictions, local protectionism, cutthroat price competitions, hard-to- penetrate distribution channels and bad debt were impacting negatively on the domestic sales of Liu yang fireworks. However, most of these problems are solved by the aids of Liuyang Firecrackers and Fireworks Industry Department. The government agency started an offensive strategy. First, it opened local office in most of the 29 provinces, major cities and regions to promote Liuyang fireworks. Second, it regulated the prices that Liuyang fireworks companies could quote and sell in export sales. Third, it restored to a government-to- government relationship in order to secure contracts for large public fireworks displays in each province. With the help of the offensive strategy, the obstacles on the way of running a fireworks manufactory are swept.

6. Make decision
After sufficient analysis, we can get the conclusion that the fireworks industry is potential. Jerry Yu should invest in this industry. When he selects the kind of factory he wants to invest, we strongly recommend the big factory which can make large consumer firecrackers.

7. Implementation
There are three key factor of success of the investment in firework industry:safety ,technology ,cost. When Yu starts to invest in firework industry, he just has to make sure that the factory he is investing in would use high quality raw materials in producing the fireworks to lessen the possibility of accidents and to pass the standards and regulations for safety consideration in other countries, thus, improving the exportation of Chinese fireworks . In addition, the company should also invest in high technology equipment and in research and development in order to cope up with and to exceed the improvements in the safety and style of the fireworks that are being undertaken by competitors. The workers should undergo continuous training programs in order to incorporate in the products the innovations that the research and development section comes up with. What’s more, Yu must combine the geographical advantages (labor and traditional dominance) with the modern management techniques (sophisticated management and marketing practices) to improve production efficiency so that they can cut cost and make more profit.