This blog is part of our ‘Making Firms Work’ series. Read other blogs in the series: on textile manufacturer A to Z and Nepalese ICT firm CloudFactory.
Dirk Willem te Velde (SET Programme Director, ODI)
10 April 2018
Over the past two decades, many low-income countries have faced major challenges in developing their manufacturing sector. In much of Africa, the share of the sector in gross domestic product has declined or barely changed in the past two decades (although there are also some examples of success, and in absolute terms manufacturing production doubled in a decade). The value of preferential market access has been under erosion, and jobless industrialisation is increasingly a reality.
However, UK-owned Hela Clothing located in the Athi River Export Processing Zone (EPZ) (close to Nairobi) shows us that it is still possible to establish a major labour-intensive factory in Kenya. They have exported $40 million (equivalent to around 10% of Kenya’s garments exports) within one year and have already created 4,000 jobs directly. We ask- what are the factors behind this success, what the current challenges are and what lies ahead?
Hela in Kenya: Beyond low labour costs and preferential market access
UK-owned firm Hela Clothing is headquartered in Sri Lanka with an annual turnover of $250 million. With demand outstripping the production capacity of their facilities in Sri Lanka and factories upgrading in Sri Lanka, Hela decided to set up subsidiaries in Mexico (to be physically close to the US, where many buyers are located), and also in Ethiopia and Kenya, to benefit from the African Growth and Opportunities Act (AGOA) whilst using labour that is cheaper than in Sri Lanka.
In Kenya, the factory was set up inside a ready-made shed. It has grown remarkably fast, reaching a turnover of around $40 million over the past year. It is likely to meet close to $60 million in the coming year. To keep up with this growth, the factory needs to double its workforce to 8,000. In comparison, the factory in Ethiopia has a turnover of $2 million and employs fewer than 1,000 workers – even though wages are much lower in Ethiopia.
The factory in Athi River is about much more than using low labour costs in the context of preferential market access in the US. Even though wages in the Kenyan subsidiary (somewhat less than $150 a month) are more than double those in Hela’s Ethiopian subsidiary in Hawassa (a little over $50 a month), labour productivity in Kenya is also much higher (efficiency is even higher than in Sri Lanka), product variety is greater and absenteeism is lower, as are ancillary staff-related costs.
In addition, the Athi River factory offers meals for its workers, a crèche for young children of the workers and a development programme for local managers. The number of expats has decreased from 60 to 40 (currently around 1% of staff) since operations started. Hela is regarded as a showcase firm in the Athi River EPZ (opened by Kenya’s cabinet secretary) and works with UK-funded programmes. The firm has also built up excellent relationships with its clients, striking deals with world-class buyers in the US such as PVH, which includes the brands Tommy Hilfiger, Calvin Klein and Speedo, and Vanity Fair.
Challenges for labour-intensive manufacturing as the window of opportunity closes
The example of Hela Clothing is all the more remarkable given that two factors exist that are likely to make it more challenging to embark on labour- and export-intensive industrialisation strategies in the future.
First, the value of preferential access will be eroded. AGOA (under which most of Hela’s garments are exported) is a US unilateral scheme that is expected to run only until 2026. Multilateral trade liberalisation is further reducing the value of the preferences Kenya enjoys, (though all countries may face a protectionist backlash in the future).
Second, recent SET research shows that the digital economy will begin to affect African manufacturing directly or indirectly. Digitalisation, automation, 3D printing and robots will change the nature of production in developed and developing countries. Robots can now undertake some tasks, and responses to rising wages in countries such as China include automation, not just relocation of manufacturing production to low-income countries. At present, capital costs required to invest heavily in digital technology are relatively high compared with labour costs, but this may not continue beyond a further 15 years for some tasks in certain sectors. Some of the automated cutting machines in the AtoZ factory in Arusha already look more modern than the cutting procedures in the Hela firm.
This suggests it is crucial for Kenya to build up industrial capabilities in the coming decade, while it still can. The existence of readily available labour and trade preferences needs to be complemented by high-quality but cheap access to energy, more and better developed economic zones and low transport costs. In addition, developing quality services (e.g. insurance, accounting, logistics) to support Kenya’s manufacturing hub, is critical.
Lessons learned and ways forward
Given its excellent client relationships and building of social capital with key sourcing companies such as PVH, Hela is looking to expand. For example, Vanity Fair (whose orders are currently responsible for just a few production lines in the factory) would like Hela to create a separate factory with a bigger crèche.
Making firms work well requires actively helping to solve problems that individual investors face. For example, a general expansion of production requires finance. Public and private actors will need to work together to fill the finance gap. So far, commercial banks in African countries have shown little understanding of ways to finance the garment industry (e.g. through letters of credit) – we can compare with this the facilitator role played by banks in Sri Lanka and Bangladesh and in Asian garments more generally. The government of Kenya has begun to focus on this, but in the meantime there is an opportunity for development finance institutions (DFIs) such as CDC, Proparco and DEG to provide tailored access to capital. DFIs could set up an East African industrial fund for this purpose.
The relationship between Hela and public agencies is encouraging, suggesting foreign investors with patience and diligence to develop strong networks can expect a return. The firm worked with the Export Zones Processing Authority on importing and exporting licensing, and with the Government of Kenya to obtain affordable access to electricity. Hela is also working with willing partners such as the UK Government (both the Trade and Development Departments) and donor-funded agencies, such as TradeMark East Africa. Together they are working with Hela as an industry-lead to support the Government of Kenya in policy development, reducing trade costs, and identifying new manufacturing locations. For example, a combination of hard and soft infrastructure improvements to Mombasa port are making the area more attractive for export-intensive manufacturing firms.
The UK’s support for Hela and tackling constraints it faces is a good example of the UK’s new trade and investment for development offer. Beyond thinking about the trade, investment, migration and other non-aid policies described in a previous SET blog, UK support is at the centre of the overlapping circles between developing country objectives (developing the manufacturing sector is currently a core priority of Kenya’s president) and UK foreign, and commercial, interests. Working with firms to support peer learning to magnify the results across a sector is also an important way of working which has come out of major DFID-funded research programmes such as DFID-ESRC Growth Research Programme, PEDL, IZA and Tilburg University.
Fostering clusters through development of EPZs and SEZs at appropriate locations could help to increase the impact on Kenya. Hela estimates it imports around 60% (e.g. fabrics) of its turnover, mainly through Mombasa port (although some fabrics may soon come from Arusha), and exports close to 100% of its products, indicating that 60% of Kenya’s export revenues actually go to other countries. Trade costs are therefore an important factor, and the firm is currently searching for additional factory locations around Mombasa so it can reduce these further. The company adds 40% of the value through cutting, stitching, embroidery, washing, putting on buttons, labelling and packaging. Some of its imported products (e.g. belts for Speedo swimming trunks) and services (e.g. business services) could be generated in factories or service providers that could set up in the same zone as Hela, fostering clustering and agglomeration effects. Country-wide, Athi River and Mombasa are not the only possible locations for such clusters. Recently, a Dubai-based firm said it plans to build a garments factory employing 10,000 jobs in Naivasha using locally available geothermal energy. Local firms could supply to and learn from lead firms, thereby increasing value addition in Kenya.
Despite the challenges, firms like Hela Clothing and AtoZ (see the first SET Making Firms Work blog) show that productive, socially responsible, competitive manufacturing firms can thrive and create thousands of jobs in African countries. More firms such as these are needed to take advantage of the window of opportunity that still exists in African manufacturing. In addition to highlighting the challenges of job creation in manufacturing in the future (and helping prepare for a services and digital economy), all actors need to rally behind Kenya’s recently launched Big Four Agenda, which includes an emphasis on manufacturing. Together with the Kenyan Association of Manufactures we developed a 10-point plan to increase the share of manufacturing in GDP from 10% currently, to 15% in five years, and double manufacturing employment. There is also an opportunity for donors to support such efforts, including by developing UK’s post-Brexit trade and investment for development offer in developing countries. Elsewhere, we have estimated that East Africa needs to create 7,000 additional jobs each day until 2030 simply to keep up with demographic developments. That is one Hela each day!
Photo credit: Adan Mohamed via Kenyatalk