At the start of the year, China looked like a bad place for manufacturers to be.
In late January, factories across the country shut down in order to contain the spread of COVID-19. In February, the manufacturing index, which measures factory output, plunged to a record low. U.S. companies with Chinese production lines issued earning warnings. Shortly after, pundits predicted more manufacturers would leave China as the coronavirus proved that concentrating supply chains in China was a risk.
Recently, Washington’s eagerness to blame Beijing for the coronavirus pandemic has added intrigue to the idea that U.S. manufacturers will up and leave China, as politicians seek to hold China “accountable” for the outbreak that first emerged within its borders.
Reuters reports the Trump administration is contemplating deploying tax incentives and re-shoring subsidies to lure companies into relocating. An anonymous official says there is a “whole government push” on the initiative. But despite the pressure from public sentiment against China and the appeal of tax breaks, not many firms look ready to take the bait.
Good to be here
According to a survey from the American Chamber of Commerce in Shanghai last month, over 70% of U.S. companies operating in China had no plans to relocate production and supply chains. In fact, only 4% have plans to move manufacturing out of China—compared to roughly 20% of respondents to a similar survey last October.
In 2019, when the Trump administration’s trade war tariffs were biting hard, tech companies including Apple, Microsoft, Dell and Amazon all announced they would shift supply lines of U.S.-bound exports to other countries. Even then, however, few companies were planning to exit China altogether and instead opted for a “China plus one” strategy.
“China plus one was a tariff play,” said Trent Davies, a manager at professional services firm Dezan Shira in Ho Chi Minh, Vietnam. “Companies didn’t want to move all the way out of China, but they did want to change the country of origin on their products in order to avoid the tariffs. To do that you need to move a significant part of production to another country.”
Vietnam was the primary landing ground for U.S. manufacturers exiting China in order to skirt the trade war. The South Asian nation has seen a steady rise in low-tech manufacturing, such as textiles and toy-making, as China’s rising wages prompted companies to find cheaper labor.
Davies says that during the height of the pandemic, the majority of companies planning to exit China actually put their plans on hold. The outbreak created too much uncertainty. Next year, however, Davies expects there will be a resurgence of interest in Vietnam, as China-based manufacturers seek to mitigate the risk of another China shut down.
Mitigating risk might mean moving a portion of manufacturing out of China, but with China’s economy slowly reopening while much of the world remains in lockdown, the country is once again among the best locations for manufacturers to be.
“The notion that getting out of China is the answer is proven to be wrong. China has recovered quicker than anybody else,” said Olaf Schatteman, a partner at consultancy Bain & Company. Factories in China began opening up again in February, after two weeks of lockdown. By March the government was declaring a resumption rate above 90%, although that figure counted even a single returning employee as a ‘resumption.’
The real problem, Schatteman says, is that many companies concentrate their supply lines through single points in China, leaving them prone to failure. Auto parts manufacturers, for example, are heavily concentrated in Hubei province, where the outbreak began. In February, Hyundai had to close its assembly plant in South Korea because its component manufacturers in Hubei had temporarily closed.
So the answer is not to leave China, but to build flexibility into existing supply lines by nurturing alternative suppliers and, importantly, maintaining a macro view of issues affecting a supplier’s suppliers.
Drew Woodhouse—another partner at Bain & Company, who co-authored a report on supply chain resilience with Schatteman—calls “upstream visibility” the “holy grail of risk mitigation.” However, even in China—where most supply chains are comprehensive, running all the way from parts to finished products—gaining insight on the challenges facing your supplier’s suppliers is not easy.
Many Chinese component makers are small “mom and pop” shops that lack the technology to plug in to a comprehensive supply chain registry where they can share stock and sale data with other suppliers. Woodhouse says the disruption caused by the pandemic likely gave big manufacturers an impetus to invest more in upgrading the data collection capabilities of their smaller suppliers.
“What we need to build is more resilience at a single point of failure, you need an agile network with multiple points of supply and a good overview of problems affecting your suppliers,” Woodhouse said. According to the Bain report, published last week, maintaining a flexible supply chain expands output by up to 25% while “cutting costs and improving cash flow.” Olaf says “unit costs may go up but system costs go down.” Avoiding disruption improves overall efficiency so the real cost of manufacturing is reduced.
Those are costs that could be saved not just when the next disruption hits, but during more placid times too—whenever they may come.
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