Is It Time To Look For Manufacturing Locations Beyond China?

For the last several decades, China has attracted production facilities across nearly every industrial sector. But as China’s cost advantages erode and trade tensions escalate, some may be having second thoughts. Apple, for example, recently revealed it has asked its suppliers to analyze the cost impacts of shifting 15-30% of production capacity from China to Southeast Asia destinations.1 For others, it is becoming more critical to proactively evaluate options for alternate low-cost manufacturing locations.

China’s evolution as a destination for Western manufacturers accelerated after its entry into the World Trade Organization in 2001. As U.S. and European firms shifted high labor content factories to lower-cost markets, China attracted an increasing share of deployments, many locating in Special Economic Zones (SEZs) especially set up to accommodate export-oriented production. China’s advantages were numerous, chiefly its vast pool of relatively low-cost labor, tax holidays, and a regulatory environment that made it easier for foreign manufacturers to set up shop quickly. Western companies flocked, and China’s coastal SEZs, most notably those with close proximity to ports, started to fill up. Production and management wages along the coast started to increase faster than inflation, and companies began to deploy farther from the ports in order to keep labor and real estate costs low.

Over time, China’s middle class gained economic purchasing power, and Western firms began to deploy factories oriented to serve the domestic Chinese market. One example is a number of Western auto factories that located to China, not to export vehicles back to the West but to serve local demand. This second wave of China manufacturing deployments added further demand for labor and management, as well as for production sites that were well-served by infrastructure and utilities.

China’s economic priorities began to shift over the last 10-15 years. China placed greater emphasis on attracting higher-value manufacturing, research and development, and automation.2 Western companies seeking to deploy production to China could generally anticipate double-digit annual wage escalation along the coast, fewer tax benefits, and a tightening regulatory environment. China’s dramatic action to stop production to alleviate emissions impacts in advance of the 2008 Summer Olympics in Beijing brought global attention to the environmental challenges associated with its rapid expansion.

Western producers seeking to sell into the China marketplace faced increasingly challenging headwinds in terms of regulatory obstacles, poorly-enforced protections of intellectual property, and preferential considerations for domestic competitors. In 2015, China released its Made in China 2025 strategy, a plan to upgrade its domestic manufacturing value chain. The strategy set goals to increase the domestically-produced content of specific high-value industries such as automotive, aerospace, IT pharmaceuticals, semiconductors, medical devices, machinery, and robotics to 40% by 2020 and 70% by 2025.

On top of this backdrop, the current environment of trade tensions resulting in increased U.S. tariffs on China-produced goods has prompted companies to consider alternative options. Over 80% of American companies surveyed by the U.S.-China Business Council in 2019 reported that trade tensions have affected their business operations in China, an 8% increase from 2018.

Furthermore, the share of U.S. companies that have moved or plan to move operations out of China increased to 18% of 2019 respondents, compared to just 10% in the prior year. 5 While China might still be a logical solution for production operations, companies would be well-advised to consider the tradeoffs of alternate locations.

What are the potential options? Due to wage advantages, Vietnam, Indonesia, Malaysia, Thailand, and India are among the common Southeast Asian candidates for manufacturers looking to expand beyond China. Indeed, since June 2018 over 30 Chinese companies have announced plans to set up or expand production abroad, with 70% going to Vietnam.6 But the reality is that companies need to undertake a holistic view of costs and operating conditions, beyond labor arbitrage, to optimize location strategy. For example, Western companies should not expect the same scale and manufacturing ecosystem advantages that they may realize in China. Infrastructure limitations (crowded highways, long lines at the ports, power outages) may be a challenge in several ASEAN locations as local authorities try to keep up with the needs of new industrial entrants. Finding new suppliers and service providers is not a given in each location. Operational risk factors, taxes, customs/duties, and entity structuring issues must be well-understood.

Evaluating manufacturing location alternatives and opportunities should be part of every company’s global footprint strategy, as the mix of costs, risks, and industry ecosystems across the low-cost country spectrum continue to evolve. While China may continue to be a viable manufacturing location, the changing operating and cost environment should prompt every company with production capacity in Asia to understand its location options and potentially plan for change.