The Straits Times / The Business Times News on OSIM

China risks: Chinese fakes give OSIM real headache

EXTRACTING value from its huge US investment was previously seen as OSIM International's biggest challenge. Its latest results, however, have highlighted another threat: Chinese fakes. And it could prove a harder nut to crack.

Last week, OSIM, best known for its massage chairs, announced that it has swung to a net loss of $9.8 million for the third quarter ended Sept 30 from a profit of $10.4 million a year ago. Revenue for Q3 2006 grew just 4 per cent to $138.7 million.

The results included OSIM's share of losses from associated companies of $14.7 million, accounted mainly by its US subsidiary Brookstone. That wasn't a major surprise to the market. Since it acquired the US retail group in October 2005, the group has been equity accounting its share of Brookstone's results. And historically, Brookstone incurs losses in the first three quarters but makes a significant profit in the fourth quarter to result in full-year profitability.

What caught the market off-guard was the poor performance in North Asia. OSIM's revenue in North Asia, its biggest market, fell 5 per cent from a year ago, while same store sales fell by 11 per cent year-on-year and 40 per cent quarter-on-quarter.

The reason? OSIM was hit by imitations of its products in China, and their inferior quality and unsubstantiated performance claims caused adverse media publicity and hit sales of genuine OSIM items. The episode involved mainly Chinese-made fakes of OSIM's best-selling uZap body trimmer. Consumer complaints eventually led the Chinese authorities to intervene in August to ban the television advertisements of the imitation products.

While OSIM believes the development is a one-off affair, the problem may not be as simple as that.

Well and truly zapped: TV ads of fake uZap body trimmer were banned by the authorities

The fact is OSIM - and other international brands - are up against a deeply entrenched culture of piracy in China. The world's biggest consumer market offers little in the way of intellectual property (IP) protection. The Quality Brands Protection Committee (QBPC), an anti-piracy body under the China Association of Enterprises with Foreign Investment, estimates that counterfeits outnumber genuine products in the Chinese market by two to one. While producers and retailers of imitation products are motivated by profits, there is also widespread acceptance of piracy by consumers. Rising incomes have created demand for premium goods, but Chinese consumers have become so accustomed to cheap copies that they are unwilling to pay the price for the real thing. The production of imitation goods, or daoban in Chinese, is a major industry, employing workers laid off by state-owned enterprises as well as migrant labour. Unsurprisingly, while there are IP laws, these are patchily enforced. And as OSIM has noted, the penalties for flouting IP laws are far less than the cost of taking legal action.

This is why some market watchers fear OSIM's problems with imitation products in China may not go away so easily. While there was a clampdown by the Chinese authorities on unsubstantiated advertising of the uZap copies, traders may still push the product if they do not make unproven claims. There are also plenty of other OSIM products for the imitators to copy - especially smaller items like iGoGo, a neck and shoulder massager, and iSqueeze, a foot massager, and less complex massage chairs like the iMedic. It is also certain that the copycats will strike again.

Big global names like Rolex or Adidas will not be crippled by Chinese fakes, but the impact on smaller companies like OSIM will be more keenly felt, as demonstrated by its Q3 results. Yet, the vast Chinese market is one OSIM cannot afford to ignore. Until the IP legal framework becomes stronger, OSIM's only real option is to continuosly churn out new products and stay ahead of the imitators. The two-year product cycle is clearly gone, and even one year may be too long. The concern is that this will jack up advertising and promotion expenses, and research and development expenditure.

The uncertainties in North Asia make it even more important that Brookstone in the US delivers in the fourth quarter as promised. Already, confidence has been shaken, with OSIM shares hammered down over 15 per cent last Friday. Without a doubt, founder and chief executive Ron Sim will be up to the challenge, but he now has to convince investors to stay the course.