SARS: Damage in the Delta

How hard will the new disease hit southern China?

Peek into Proview International Holdings Ltd.'s eight-story factory in a dusty industrial zone outside Shenzhen, China, and you'd never know it's a stone's throw from ground zero of a worldwide health crisis. Just a few kilometers away in Hong Kong, companies and governments are evacuating staff. Those who remain hide behind surgical masks and obsessively wash their hands to avoid getting severe acute respiratory syndrome, or SARS. And somewhere just a few miles to the north -- in Guangdong Province -- lies the probable origin of the virus that has killed more than 100 and sickened at least 2,700 others worldwide.

But at Proview's plant, it's business as usual. Some 5,000 young women working in shifts around the clock quietly assemble nearly 30,000 computer monitors a day. Business is growing so fast that Taiwan-based Proview is scrambling to complete a second factory next door. Although the company gives workers tips for preventing SARS, few opt to wear masks. "So far, we've seen no big impact," says Proview Executive Director Morris Wang. "I tell my staff to avoid going to public places, but they're working so much overtime they don't have time anyway."

It's a common scene in Shenzhen and elsewhere in the booming Pearl River Delta. Despite the near-panic across the border in Hong Kong, few people in the region wear masks. And there have been virtually no reports of factory slowdowns or delayed shipments in the five months since the SARS outbreak began.

The question is whether that situation can last. SARS could be the biggest challenge China's manufacturing sector has faced since the 1989 Tiananmen Square massacre. For the past decade, the Pearl River Delta has emerged as a seemingly unstoppable manufacturing juggernaut, churning out $110 billion in exports annually while sucking in $17 billion in foreign direct investment. The region's low wages, good infrastructure, and efficient logistics simply can't be matched elsewhere. As a result, the Delta has become one of the world's most important production bases for everything from stuffed toys to PCs, thanks to an explosion of investment from Taiwan, the U.S., and Japan.

But now, some of those companies are beginning to see risks they may not have perceived before the outbreak. "If this goes on for another two or three months, it will raise the issue higher and higher in peoples' minds," says Michael Marks, CEO of Flextronics International, a global contract-electronics manufacturer that has 33 factories in China as well as facilities in 28 other countries. "It will be on the agenda of every board meeting." A report by Boston tech-market research firm Aberdeen Group warns that "in the worst case, SARS could result in major supply-chain disruptions and another downdraft for an already challenged industry."

There are some early warning signs. Dozens of multinationals -- including Cisco (CSCO ), Toshiba (TOSBF ), and Taiwan Semiconductor Manufacturing (TSM ) -- have restricted or banned travel to Guangdong and Hong Kong. Continental Airlines Inc. (CAL ), bereft of passengers, has suspended all flights to Hong Kong, while other airlines have cut back schedules sharply. Marks says several big customers have asked him about alternatives to the delta since the outbreak began. And some experts warn that the virus could boost the appeal of countries that have lost factories to China. "Investors in Southeast Asia can go look at their investment without the risk" of contracting SARS, says John Stuermer, a Singapore managing director at brokerage Bear, Stearns & Co.

In reality, though, it won't be easy for rivals to eclipse the Pearl River Delta. Unless the SARS outbreak lasts for many more months and gets far deadlier, the region is not likely to lose much business. The delta has simply become too important a link in the global supply chain. For instance, Guangdong is the world's biggest producer of printed-circuit boards -- used in a wide array of tech products -- as well as a vital source of plastic moldings, packaging, connectors, and other supplies. That allows electronics companies to get parts deliveries almost instantly. "You can transfer that to other countries, but it would take years," says Gene Sheu, president of the networking and information group at First International Computer, a Taiwanese maker of computers and PC components that does about 75% of its manufacturing in southern China.

Moreover, any gain China's rivals get from SARS may be short-lived. As the virus spreads around the globe, countries that compete with China are already grappling with the disease themselves. Malaysia, for instance, has 40 suspected cases and two deaths. "SARS is a wall-less problem," says Mohammad Ariff, executive director of the Malaysian Institute of Economic Research, a Kuala Lumpur think tank. "If it spreads, it's unlikely that investors would be attracted to Malaysia or Indonesia." And the risk of terrorism -- virtually nonexistent in China -- is a big concern in Southeast Asia.

That's not to say factories aren't hurt at all. Proview's Wang says managers and technicians from Taiwan and Hong Kong, as well as customers from the U.S., Europe, and Japan, are canceling dozens of meetings weekly. Moreover, while the isolation of factories such as Proview's makes it easy to keep SARS at bay -- most workers live in dormitories adjacent to the factory floor and rarely venture out -- that same isolation means one carrier could quickly spread the virus and shatter the sense of calm overnight.

Another fear is that the SARS scare will drag on for many more months and affect shipping. An abrupt cancellation of air freight flights could disrupt just-in-time deliveries of computer chips and circuit boards. Big delays at sea ports could force factories to send bulky items such as computers or monitors across the Pacific by air, wiping out the cost advantage of producing in China. Such problems, in turn, might prompt multinationals to cut back on new investments in the delta and instead shift some production closer to home.

Much depends on how well the Chinese government handles the SARS crisis. Despite an early reluctance to reveal the extent of its spread, some optimists believe Beijing has learned a lesson from SARS. "The intensity of criticism about the lack of transparency has probably sunk in" with China's top leaders, says Jun Ma, an economist for Deutsche Bank in Hong Kong. Given the difficulties of shifting their manufacturing operations out of the delta, the world's electronics manufacturers must certainly hope he's right.

By Bruce Einhorn in Hong Kong and Pete Engardio in Shenzhen, with Michael Shari in Singapore

— With assistance by Michael Shari

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