ZIBO, China — Zibo is the homeland of Luthai Textile Ltd., one of the largest manufacturers of shirting fabric in the world. Located in the Shandong province in Northern China, Zibo is a typical Chinese industrial city. A long dusty road, named Luthai road, bisects the city from end to end and serves large industrial areas dotted with chimneys belching suspicious yellowish smoke. Along the road, there are many scooter repair workshops, greenhouses and small restaurants. Further in the gray mist, are buildings where 5 million inhabitants are sleeping. Although, in 2009, Zibo was named one of the 10 most harmonious cities in China, a summer holiday destination it is not.

From coal mines to cotton fields

Luthai was founded in 1988 by Liu Zibin, a former entrepreneur from the coal industry. Mr Liu humorously explains his motivation was to move from “black” business to “white” business. The company now employs around 18,000 people and weaves 164 million meters of cotton fabric per year, 10 times more than Deveaux, the leading European dyed-yarn weaver. Luthai also owns farms in Xingjiang that produce 16,000 tons of cotton and supplies 20 million shirts to major international fashion brands. Chances are that the fine cotton shirts — plain, with stripes or checks — in your wardrobe are made of fabric that came from Luthai's production line.

Export-driven success

Luthai's success over the past 20 years was primarily built on an attractive price-to-quality ratio. Global buyers came to Zibo to find the right blend of cotton quality, weaving techniques and pricing. Uniqlo buyers place orders of several million meters, as did the sourcing teams of Hilfiger, Sears, Zara, Burberry and Zegna. Indeed, 70 percent of Luthai's turnover is made through exports and sales have doubled from 450 million euros in 2006 to 900 million euros in 2012.

The end of the golden years

But after 20 years of stratospheric growth rates, Luthai's success formula faces new challenges. The recent volatility of cotton prices (the firm imports 50 percent of its cotton supply from the USA) induced unexpected financial charges and the rise of Chinese wages by 20 percent per year over the past 5 years has reduced margins. Indeed, nowadays, Vietnam, India, Indonesia, Cambodia and Mexico offer more attractive costs than China and retail giants such as Coach or Ann Taylor have seriously considered relocating their sourcing and production factories.

Clients are kings in the Luthai kingdom

To avoid such a peril, Luthai pampers its clients. The company has built a luxury resort close to its offices and factories which receives dozens of international buyers daily and entertains its crucial guanxi (network) of Chinese officials. At lunchtime, guests climb a double-helix staircase to reach a restaurant decorated with an extravagant trompe-l'oeil of blue sky and white clouds. The sense of luxury is a bit tacky, but the food is refined and Luthai's chef impresses the visitors by serving exclusive delicacies such as prickly sea cucumbers or strange Tibetan magic mushrooms, insects in winter and a plant in summer (Cordyceps sinensis) that is said to have aphrodisiac properties and costs about $800 per kilo.

Moving up the value chain

But most importantly, Luthai's management anticipated the shift of China's textile industry from exports at low prices to a new stage where productivity, product innovation and domestic demand are the new priorities. Hence, its awaking is not too rude.

The upstream integration of the value chain has been driven by a compelling logic. As Luthai’s CEO puts it: “With good cotton, you’ll make good yarn; with good yarn, you’ll make good fabric; with good fabric, you’ll make (good) clothing! And all this requires good equipment and good manufacturing processes.”

Luthai invested in sophisticated machinery to enable productivity gains and offer a larger palette of weaving techniques. To address the challenge of innovation, Luthai appointed Italian and French experts to train textile designers and help them develop trendier fabric collections. Innovation pays. In 2012, orders for new products accounted for 53 of orders and 65 percent of revenues.

Fishing from both sides of the pond

The conquest of China’s domestic shirt market has been much more erratic. From the beginning, the shirt business met a very specific need for Chinese companies: the practice of corporate gifting. Since Luthai’s heavy industrial fabric rolls didn’t fit in the luggage of government VIPs, shirts were first produced as much lighter gifts.

Then, the fashion venture actually began in 2000 with the purchase of the distribution license for Arrow, a well-known American brand. With 200 boutiques around China, Luthai gained its first fashion retail experience. The firm then launched two brands: a premium label called LT-GRRF and a second more mainstream one called BESSSHIRT, sold exclusively on the Internet. LT-GRFF refers to Luthai’s mascot, the griffin, while BESSSHIRT is a portmanteau of best and shirt.

For a couple of years, the two brands were sold almost exclusively to Chinese government officials, but recently, the company’s management decided to put more efforts into their development. The results are still uncertain though. The brand director is a former textile technician who knows little about consumer expectations and even less about premium brand management. The head of design is young, with only one year of experience at Metersbonwe (a Chinese mass-market fashion retailer). This lack of experience has given rise to some memorable missteps. Although Luthai has probably the largest catalog of shirting fabrics in the world, the style director ended up outsourcing printed fabric to competitors. Shocking!

The pursuit of manufacturing excellence is part of Luthai's genes and going upstream is a natural reflex of Chinese industry. However, it is much harder for the company to generate market insights, understand competition dynamics and create distinctive brand identity. Branding activities require soft skills that have not flourished in Zibo yet. The future challenge for Luthai will be to tame the complexities of design, marketing and distribution.

Genevieve Flaven is CEO of Style-Vision Asia, a trend agency based in Shanghai.

Disclosure: Luthai Textile Ltd. is a former client of Genevieve Flavin.