Most of the toy manufacturers process toys for foreign brands, meaning they are small in scale and low in profit. A Dongguan research report reveals that, only 2 percent of the 649 toy companies surveyed in 2004 had their own independent brands. "Most of them don't have their own core technologies," the report stated. "They lack innovation, and their equipment is old."

In recent years, the cost of manufacturing has risen due to the appreciating Renminbi, the Chinese currency, new regulations and a shortage of skilled workers. Some toy companies, finding hard to sustain themselves, have moved to less-developed inland regions, as well as to neighboring countries such as Indonesia and Viet Nam.

Under such circumstances, some toy companies cut their prices to the minimum in order to secure orders. "The low cost has forced some toy companies to choose unhealthy raw materials which will cause damage to consumers and this is also one of the reasons for the rising numbers of recalls," said Leung.

Innovation is key

Since most of the products are foreign branded, the profit ratio of Guangdong's toy industry floats at only around 1-3 percent. Moreover, increasing technical barriers from the United States and European Union have added pressure to the industry. For instance, the European Union has issued stricter standards covering six toxic ingredients including lead, hydrargyrum, cadmium, hexavalent chromium and PBDEs. It also ordered that after the toys are discarded, producers and distributors must recycle and pay for the disposal.

Significant changes have taken place within the toy industry. Many small and medium-sized companies are worried about how to obtain licenses and qualified inspection reports, leading to nose-diving revenue. However, the order sheets of some large companies have increased 50 percent compared to the period before the Mattel recalls, and they have to work day and night to fulfill the orders.

"The changes have made many companies realize that price wars no longer work as they did before," Leung said. "If you want to survive, innovation and continuous efforts to increase added value are essential."

After years of development, the technology level of the Guangdong toy industry has reached the international standard. Generally speaking, toy quality there can be guaranteed. Statistics show China exported 300,000 batches of toys to the United States in 2006, and of these, there were only 29 cases of recall.

Eyeing the future

The Mattel toy recall incident has taught many toy companies a lesson, and some local governments have begun efforts to upgrade these industries. Xiao Naixiong, a policy research officer of the Dongguan SSL Science&Technology Industry Park, said that the city government is conducting a survey among Dongguan's toy-manufacturing companies, and, based on this, it will issue a report involving policies encouraging the upgrade of the toy industry.

In order to do this, the Dongguan Government is striving to build sound platforms for companies and research institutions to develop a new generation of hi-tech toys. The Guangdong Electrics Industry Institute (GEI) is one such platform. Tang Zhenchu, Vice President of the GEI, said the institute has invented system-on-a-chip technology that can reduce the cost of intelligent toys from several thousand yuan to several hundred yuan.

Tang said many toy manufacturers are interested in this technology and will soon negotiate for cooperation possibilities.

Large toy manufacturers have already realized the importance of upgrading their products. Lung Cheong Holdings is a typical example.

The company started as a small workshop in Hong Kong in the 1960s and manufactured toys under other brands. Eight years later, the company bought second-hand plastic processing equipment to produce Christmas trees. Through cooperation with big Japanese toy companies like Taiyo and Tomy, Lung Cheong Holdings became recognizable in the industry.

In the early 1970s, Lung Cheong Holdings moved its factory to the mainland to cut costs, while the Hong Kong headquarters remained responsible for product research and marketing. Since its listing in Hong Kong in 1997, the company has enjoyed sufficient capital and has been able to direct more attention to hi-tech toys.

"The profitability of traditional toys is very low, while that of digital hi-tech toys can reach 30 to 40 percent," said Chen Yuchuan, a senior manager with Lung Cheong Holdings. "The market teaches us we must innovate in order to survive."

Leung said that 3 to 5 percent of the company's 800 million yuan in annual sales revenue will be dedicated to research and development. Currently, the company has about 6,500 employees and around 320 are engaged in research and development, covering every aspect of toy production.

In Leung's company, original equipment manufactured (OEM) toys account for 50 percent; original design manufactured (ODM) toys make up 25 percent; and original brand manufactured (OBM) toys take 15 percent.

"Our goal is to increase our OBM to 50 percent in the next five years," Leung said.