CASE 2 – ESQUEL GROUP

What special risks are there for a foreign company in locating a factory in China? How can they be
mitigated?
Esquel has proven to be extremely successful in locating some of its factory’s in China and has
taken advantage of China’s emerging economy. However, there are several special risks for a foreign
company in locating a factory in China. The first one, and perhaps the most important one, has to do with
politics and the fact that China is a communist country with a socialist market economy. This type of
economy has several strict rules regarding the administration and ownership of companies. A socialism
economy favors that the wealth of its people is shared equally. Therefore, having a successful and
profitable factory in China might mean to loss revenues due to these policies.

One of the policies mentioned in the case is the use of a strict quota system for private companies
producing to the U.S. market. These types of reforms first began in the countryside and later moved to the
cities. They make it hard for companies to capitalize business opportunities and specifically in this case,
for Esquel. However, they managed a way around this by moving their growth towards other Asian
countries that were not restricted by this U.S. quotas, like Malaysia and Singapore. Also, these quotas
limited the number of garments that could be sold but not the price. Esquel made use of this by increasing
the quality and the value-added of their products and sold them at a premium price. Furthermore, by
owning the supply chain with vertical integration, it was able to move around without having a major
impact on quality.

Another risk of locating a factory in China is their lack of infrastructure. The case mentions that
one of the reasons they had to close their stores and reconsider their brand was because of lack of
management due to this poor infrastructure in China. This can be a major problem for any foreign
company too. Esquel found a solution to this problem by spending over $500 million in improving
infrastructure around China. However, this is a big capital outlay and many people could argue that it
could have been better off spent somewhere else. Also, many companies won’t even have access to this
much capital without increasing their debt and consequently their risk.

Moving onto more general risks, there might be problems with cultural differences like for
example, language barriers. Each country has a different set of cultural values and it's extremely
important to know and understand them. To mitigate these risks, it’s important to make sure to make
connections with local companies by being accommodative. It's also important to learn their culture and
promote appreciation for these differences. Other general risks to take into consideration are loss of

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 reputation if the investment goes wrong and currency exchange risks. There are some ways to mitigate
both risks. Firstly, a company should study beforehand the option of locating a foreign company in China.
This way the likelihood of it going wrong decreases. Lastly, many hedging techniques can be used to
mitigate currency exchange risks.

How should Esquel think about its factory investments in China vs. other countries in the region?

Esquel has experienced sustainable growth over time. They were able to achieve this growth
because they gained competitive advantage by growing the company and investing in CSR. The places
where Esquel decided to invest in were full of strategic thinking.

They chose to expand in places like Gaoming or Xinjiang for several reasons. First, it was a city
yet to be developed, therefore buying land was cheap. Secondly, they would be able to bring cheap
external labor force into the area. Lastly, it was a city that was geographically attractive and therefore had
huge economic growth potential. Esquel also moved into Xinjiang in order to have their own farm of
cotton. This place provided the perfect conditions for cotton to grow. Esquel used these places to focus
production and business operations on optimizing its vertically integrated supply chain.

In conclusion, Margie thought that investing in China required more than real estate, plant
facilities, and transportation. Investing in China required “commitment to the larger nexus of social,
educational, and environmental concerns that would sustain the enterprise over the longer term.” Esquel
knew they would have to put more effort and capital into it, but they thought that in the long run it would
pay off.

What are the key elements of Esquel’s community outreach strategy and its social infrastructure
investments? Are there elements that surprised you? What, if anything, is different about thinking about
factory locations in the U.S.A. vs. China?

The main key element Esquel ingrained in their culture is corporate social responsibility (CSR).
Margie focused on the wellbeing of the workers and community. This increased both their quality and

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 competitiveness. They developed a five-point “eCulture” that works as their main community outreach
strategy. When I visited their webpage this “eCulture” was one of the first things I saw.

As I mentioned briefly before, they invested in Gaoming as a joint-venture partner. Esquel

Esquel also focused on building a “shared understanding with the local, provincial, and central
government officials that business and social policies were mutually beneficial.” They worked closely
with the Chinese government and proved that the private sector could benefit both business and society.

Margie believes their people are their biggest asset. She understands their needs and pays high
attention to their health, safety, and work balance life. In addition, she also built schools and established
educational and social programs. With the use of its skilled and committed labor-force, Esquel's
management was able to boost efficiency with continuous innovation in technology. They were more
productive while also minimizing the environmental impact (Their webpage mentions that by doing so
they’ve been able to reduce energy consumption by 40%.)

To answer the second part of this question, I was indeed a little surprised by this strategy. In the
business world, companies usually experience heavy competition in every single market. I’m surprised
how Esquel has invested so much money into the community but has still been able to be profitable. It’s

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 not a strategy I have seen many other companies take. I believe that there is a direct correlation between
happy employees and productivity, however, it's surprising how far Esquel took this.

For the last part of the question, I strongly believe, however, that this strategy was able to work in
China because of their emerging economy. I believe Margie should have taken a different approach if she
were to build factories instead in the U.S. The infrastructure in the U.S. is already developed to the point
that spending money to make it better would have little benefits. Besides, there is access to schools and
universities all over the country. If they would have built a school in the U.S. I don’t think it would have
worked out as it did in China.

What advice would you give to Margie?

No-one could argue that Margie hasn’t done a great job so far. Esquel has been extremely
innovative with their production systems and has developed innovative ways to decrease costs. Moreover,
they’ve been extremely helpful to the environment and have managed a way to increase profits while
doing so.

However, Esquel is a company with “limited consumer brand recognition.” Margie’s goal is that
Esquel continues to be the “quality maker behind the great fashion brand.” We live in a current era where
there is a ton of competition in every single market and companies can take market share in a really short
time. Although I believe Margie has built the perfect company for the environment, they should start
analyzing more the trade-offs and start focusing more on the company itself. Many other garment
companies in the world have similar quality products but can charge a lower price if they have lower
expenses. Therefore, Margie should specifically focus on creating brand reputation.

I, as a consumer, have never heard of this company until this day. The company should make
itself known and I believe they could do this in various ways. Firstly, via marketing. I believe they don’t
do such a great job increasing consumer’s awareness for their products so they could invest more in this.
Also, they could open more outlets around the world which would increase their brand awareness. Lastly,
I have been to their webpage and noticed they don’t sell online. Companies nowadays must make use of
the advancements of technology. If a company doesn't do this, it's a matter of time that they're left behind.
In conclusion, I believe Esquel is losing tons of profits by not selling online, as well as losing brand
recognition.

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 What do you think Milton Friedman would say about Esquel’s non-business activities? What would John
Mackey say?

Milton Friedman believed in free-market capitalism and wouldn’t agree with China’s socialist
market economy. His most important idea is that he believes a company has its main responsibility to its
shareholders. This means a company should do everything in their hand to increase shareholders’ returns
within the given laws. He doesn’t favor CSR, he says this distracts companies from what truly matters
that is maximizing shareholder’s value. Friedman would, therefore, disagree with Esquel’s non-business
activities if it were to be a publicly-traded company. However, Esquel is a “private cooperative” so there
is no duty to maximize shareholder value as there are none. So, I believe Friedman wouldn’t disagree
with Esquel’s non-business activities. He would think that they could use its profits in whichever way it
wanted because shareholders’ wouldn’t be affected.

On the other hand, John Mackey is an American businessman who focused on creating a more
conscious way of managing businesses. He believes all of the suppliers, community, environment,
shareholders, customers, and employees should be taken into consideration when making business
decisions. Although he agrees profits are an important part of a business, he also gives importance to all
other things mentioned above. Like for example, CSR. Therefore, I think Mackey would agree to some
extent with Esquel’s non-business activities. He would agree Esquel is doing a great job pursuing
sustainability, but that they might be going too far. He might think they are losing too much money on
CSR.

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