When Italian manufacturers ran into competitive problems in the past, there used to be an easy fix: currency devaluation, which made Italian exports cheaper relative to those of other countries. But that solution is no longer a panacea, because Italy swapped the lira for the euro, which has risen against most other currencies. "We used to say small is beautiful, but that's no longer true," says Adalberto Valduga, president of the regional chamber of commerce in nearby Udine, the provincial capital. While the strong euro is penalizing firms, he says the real challenge is a more fundamental one: "We need to change our way of thinking." The International Monetary Fund agrees. In a tough report last month, it castigated Italy's economic policies and said the nation's waning competitiveness was due to "deep-seated inefficiencies" as much as to foreign competition. China looks set to overtake Italy this year as the world's sixth-largest economy after several years of jockeying for the spot.

The Italy vs. China manufacturing battle has a significance that transcends national borders. If the Italians can find a way to carve out an upmarket niche for themselves—as the most successful chair manufacturers are attempting to do—there's every reason to believe that Europeans and Chinese can coexist and flourish, with each building on its respective strengths. Several Manzano entrepreneurs are already looking to China as a market where they can both buy and sell. "Nobody can stop the Chinese anymore," shrugs Lucio Zamò, one of the few remaining successful manufacturers of office chairs in the district. Zamò has been able to cut expenses by building chairs using imported Chinese aluminum bases, which cost 40% less than Italian ones. But should the Europeans prove unable to resist the fierce competition, politicians may try to level the playing field by imposing protectionist trade restrictions on Chinese imports. The European Union made a botched attempt to restrict imports of Chinese textiles this year and is now considering slapping tariffs on leather shoes.

But if Manzano is to recover its mojo, the chair triangle's entrepreneurs know that they—and not politicians—will be the ones to find it. "This is a moment of maturation," says Fanin, the machine-tool manufacturer, who recently laid off six of his 15 workers. "You can't compete on price. You need to believe in the company and innovate. There's no third way."

Manzano's claim to be the chair capital dates back centuries. An eighth-century altar in nearby Cividale contains the first trace of chairmaking. During the Renaissance, local carvers and carpenters from the region had their hands full with orders from Venice, 120 km away. Production of chairs for the masses began in the 1800s but the real boom came after World War II. Big distributors, primarily from Germany, discovered the local craftsmanship and started buying in bulk, turning Manzano chairs into a $1 billion-per-year business. To cope with the demand, the number of firms grew tenfold as highly specialized artisans set up on their own, supplying individual parts to their neighbors who would then work them into the next stage of the manufacturing process before passing that on to another firm. One artisan would just do leather upholstery, for example, or specialize in varnishes. This highly decentralized industrial structure, a type of extreme outsourcing network, is quite common in Italy. By one estimate there are about 100 such industrial clusters in the country, producing shoes, clothes and even some food products.

The flexibility of such clusters is sometimes held up as a model by experts on economic development such as Harvard Business School professor Michael E. Porter. But the system has proven vulnerable to an onslaught of international competition. About 90% of the firms in the district have fewer than 20 employees, while just a dozen have more than 50, according to a study by Professor Roberto Grandinetti of the University of Padua. Local bankers say that all but a few are sorely undercapitalized and lack the resources to build their business up to a global scale. And virtually nobody has much experience selling to customers other than the big German distributors who once snapped up as much as 70% of the district's output. "Twelve years ago, I began saying that it wasn't enough just to make chairs, but that we also needed to sell them," says Giovanni Masarotti, president of the Manzano chair district and chief executive of Montina, one of the oldest firms. "If I say three companies have true marketing departments, I'm exaggerating."

None of that seemed to matter until three years ago. Then a triple whammy hit the district: the rapid emergence of China, a rising euro and a rocky post-Sept. 11 economy that made buyers everywhere extremely price-conscious. American customers were the first to look east, but the all-important German distributors quickly followed suit. Suddenly, a business that had seemed steady and dependable turned out to be anything but. "Firms that were doing well in one quarter found their sales cut in half the next," says Focacci, the local banker. "One effect of globalization is that change comes very quickly."

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