(FORTUNE Magazine) – The phone call couldn't have stunned me more. My Pacific Northwest salesperson had just informed me that we'd lost one of our most important accounts to an assault by low-cost rivals, one from China and another from Thailand. I hadn't seen it coming. This customer had always bought on short lead times and with an emphasis on top quality. Both of those factors, I figured, protected me from an Asian invasion. Wrong. When my competitors turned up with prices 60% below mine, the customer jumped right into their arms. Just to make sure I got his message, he even inquired, "Why can't you produce at the same price the Asians can?"

Did I really need to answer that? Didn't everyone in the U.S. know by now that cheap labor combined with government subsidies gives Chinese companies a huge edge over their American rivals? Evidently not. To make matters worse, my Asian competitors also enjoy raw-material costs almost 25% lower than mine, thanks to cheaper plastic resin that they can buy from Mideast suppliers who don't as yet have the facilities to ship to the U.S. China's recent decision to let the yuan rise slightly will provide only a bit of relief.

I needed an answer, and fast. Looking at the hole in my coming production schedule, I wondered what more I could do. Having been aware that this could happen, I had already taken many of the steps management gurus suggest to battle overseas competition. Over the past five years our family-owned company, which makes plastic bags, has invested more than $12 million in new high-speed equipment to slash production costs and boost quality. We've cut our costs for raw materials by as much as 10% through frequent bidding. And we've diversified into less-labor-intensive, higher-value-added products to shield against just the kind of incursion we now face. Today, for most of our products, labor accounts for less than 10% of cost, down from about 15% five years ago.

Clearly the time had come for us to get more creative. We've learned that many bagmakers in China and Thailand print with inks banned in this country because of their high concentrations of toxic substances such as lead and mercury. I sent sample bags produced by several Asian rivals to independent labs to determine whether they contained banned inks. When I found out they did, I warned my customers. No orders were canceled--it was too late for that. But they might think twice next time. I certainly got my rivals' attention: One threatened to sue us unless we repudiated our test results.

We've also redoubled our efforts to boost quality and slash costs. Recently we decided to spend more than $300,000 on a mix of software and hardware upgrades to increase the output of our largest printing press by 30%. Our family hopes to invest in a $2 million, ten-color printing press, which would elevate our capabilities to another level, since we now use an eight-color press. I've also begun looking closely at putting a factory in Mexico, where we can manufacture our most labor-intensive products. I think many of our customers would feel more comfortable buying from a factory that wasn't three weeks away by water. And a low-cost plant closer to home would allow us to provide customer service superior to that of our Asian rivals.

We'll also continue to search for new products, especially those that are not likely to become commodities soon. We're partnering with suppliers of high-tech plastics that allow fresh-cut vegetables to breathe, extending their shelf life. And every now and then we can count on our Asian rivals to give us some help. The big customer who bought from them? Well, its new Chinese supplier disappointed it--poor quality and missed deliveries--so much that its managers are talking about coming back to us next year.

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