What started as a small cotton mill in Jinan, the capital city of Shandong, nearly twenty years ago has since developed into one of the biggest vertically integrated manufacturers in China and an essential partner for some of the world’s biggest brands including Uniqlo and Burberry.

Luthai Textile’s extensive supply chain ranges from cotton farming all the way to private label brand marketing clearly differentiates the company from the average contract manufacturer. Their own label ‘L.T GRFF’ has even been acknowledged as one of China’s top brands. Massive investment in Research and Development and innovation has resulted in the company earning nationwide recognition as a National Certified Enterprise Technology Center. The company is also now considered a national R&D growth engine for yarn-dyed fabric.

With net assets worth RMB 4.1 billion (US$626.6 million) and over 20,000 employees (6,000 in garment manufacturing alone) in more than 20 different high-tech manufacturing facilities, Luthai produces 150 million pieces of yarn-dyed fabric, 50 million pieces of piece-dyed fabric and 17 million dress-shirts, each year. Zhu Ling Wen, chairman of the board of supervisors, clearly believes in the dictum that “size matters.”

Having control over every step of the supply-chain is critical in times like these: times where the prices of cotton and labor (two of the most crucial factors of production in clothing) have become the biggest problems industry-wide.

“Cotton prices will certainly drop, but not to their original level,” said Mr. Zhu. “We have our own cotton field in Xinjiang and during busy seasons we have to hire a lot of people. There used to be a lot of temporary workers from Sichuan and other parts of the inland that were willing to pick cotton but now fewer and fewer people are willing to come. Labor costs here are definitely going to increase.”

“The level of cotton prices affects us as a manufacturing enterprise, but this risk is unavoidable. The key is whether you can sell your product at a corresponding value. This is how you use product to offset risk.”

Having their own cotton fields also helps to improve supply chain coordination, reduce logistics costs, but most importantly it gives the company control over raw material resources, the key factor of production in the garment supply chain.

According to Mr. Zhu, vertical integration is not merely a matter of expansion and increasing capacity - most of the time it comes out of necessity. “With good cotton we make good yarn; with good yarn we make good fabric; with good fabric we make good clothing, but that means you also need control of good equipment and processes,” he said. “Many people would outsource part of their industrial chain but we don’t believe in doing this as it is difficult to control quality. What better way to ensure that you have the best quality than to have complete control over every process?”

The company owns restaurants and hotels for entertaining their guests and customers and even roads around Jinan for maximizing logistical efficiency.

Even in the aftermath of the financial crisis of 2008-2009, where international trade fell by more than 11 percent according to IMF estimates, Luthai has remained fairly resilient and gross margins remain at an impressive 30 percent.

“At the end of 2009, our management team said that we should prepare for a very bad year in 2010. We tightened our belts and made comprehensive plans to deal with the crisis. But to our surprise, 2010 ended up being one of the best years in our history,” said Mr. Zhu. “In part, I think this actually had to due with us feeling a sense of urgency back in 2009.”

“We will still remain vigilant in 2011,” he added.

With manufacturing costs skyrocketing and buyers becoming increasingly finicky on price, the only way to justify rising costs today to come up with new products and look to new markets.

“This is the way we will be competing for customers. Since prices are going up everywhere, it comes down to who has the better product,” said Mr. Zhu.

He believes that Luthai’s long-term development strategy has always been to parlay the company’s development with the evolving demands of the market. The period of large scale expansion from 1990 all the way to 2005 was all about growth and capital accumulation. From 2006 to 2010, the company began taking on a new and more strategic approach.

“We changed the direction of our business model from large-scale expansion to investing more in technological innovation, R&D and paying attention to our new core business, focusing on doing our own brand, and shifting more attention from the foreign markets to the domestic market.”

Although 90 percent of the company’s business is still geared for foreign export, increasing their clout in the domestic market will be a key objective for the company in the coming years.

“We have been discussing this for the last four to five years but because we have been doing foreign trade for so long, we have not made much of a major breakthrough in the domestic market yet. We hope to use our brand influence to gradually open the domestic market.”

The company has acquired a formidable inventory of unique processes, finishes and products – some in collaboration with other chemical companies such as Clariant, Invista and Asahi Kasei, and some of which are proprietary.

One such development is Luthai’s advanced non-wrinkle, iron-less Nevrion 4 fabric. Manufactured with an intelligent interweaving technique, the fabric is capable of achieving DP rating’s of 4.0 in smoothness and softness after abrasions of over 20,000 revs and over 50 washes. Nevrion 4 has already been used in the company’s private label brand of ‘L.T GRFF’ shirts.

Mr. Zhu believes his company also differentiates itself in terms of its labor relations. The company boasts well-trained staff and a “united and harmonious” management team. Labor, he agreed, has been a very real problem for Chinese manufacturers in the last few years (and will continue to persist) but Luthai managed to remain relatively insulated from the mayhem.

“We shifted our attitude from treating our workers well, towards actually caring for them. As an enterprise, if you really want to win then you must first treat your staff well,” said Mr. Zhu.

The company’s recreational facilities are not limited to just worker canteens and mess halls, workers can enjoy access to dance halls, swimming pools, gyms and libraries, as well.

In the garment assembly facilities, the latest mando-pop music is played through the stereo systems. There is indoor heating, clean, bright working areas and factory walls are even emblazoned with worker motivation banners and worker ‘liberation’ cartoons.

Though he would not comment on wages, Mr. Zhu emphasized that employee welfare was well structured and provided for.

“We actually pay for employee insurance unlike many other companies who try to work around or avoid payments. We respect our staff and this we believe is the key to workers staying loyal to our company.”

To nurture talent, the company cooperates with educational institutes such as the No.2 Vocational Secondary School of Zichuan and Qingdao University to form larger scale training programs to equip employees and prospective workers with better skills and education.

Luthai’s success story is symbolic of China’s economic success over the last two to three decades. From small cotton mill to vertically integrated enterprise, firms like Luthai offer us a sneak peak as to where the trajectory for Chinese export and manufacturing enterprises is headed. The hey-day of low-cost OEM (Own Equipment Manufacturing) production are fading away.

As Mr. Zhu states, “the key to success for the future will be to justify ever increasing costs by turning to product innovation, discovering new markets (notably China domestic market), working on brands, improving the workplace for employees and strengthening the management element” – the latter being the most vital.

“Come to think of it, so many businesses went under in the last few years. In which area did they fail? Usually it wasn’t because of their products but it was because their leadership was not united. If your leadership isn’t united then how can you manage your enterprise and generate good business?”