The China-centric supply chain may be giving way to sourcing alternatives but is still the biggest game in town.
This spring, a sudden spike in COVID cases triggered a draconian lockdown in Shanghai that lasted for nearly a month. It brought area factories and the city’s mammoth port complex alike to a standstill, wreaking havoc on China’s supply chain, and, by extension, large and wide-ranging segments of international commerce.
Earlier this month, America’s Inflation Reduction Act became law. A provision specifically targeted the supply chain for minerals and components that go into everything from electric cars to solar panels with measures aimed to reduce US dependence on China for a shift to renewable energy.
This is just the latest political measure aimed, largely through steep tariffs, to punish China and weaken its hold on American commerce. Treasury Secretary Janet Yellen recently pushed what she called “the friend-shoring” of supply chains, an obvious dig against “unfriendly” China.
These come on the back of massive COVID-related shocks that upended international trade for the better part of two years. Demand whipsawed. China, its customers, and logistics providers, were completely caught out.
Challenge to the China Centric Supply Chain
All this underscores the impression that China’s dominant place in global commerce is being threatened. In unprecedented ways. its vaunted system of manufacturing prowess, girded by well-oiled and state-of-the-art logistics and support, is under attack.
“A China-centric supply chain is being challenged by a confluence of factors,” said Carlos Cruz, a partner in the management consultancy Bain & Co. “One is a political side that is driving uncertainty. Two is a fundamental shift driven by the increasing pressures from a supply perspective.”
The trauma of the past two-and-a-half years has forced pretty much everyone involved in cross-border trade, commerce, and logistics to question the status quo. But how this big reexamination plays out is anything but certain, and how China will be impacted is a matter of intense speculation.
A few now believe that China will play a less commanding role in the global supply chain in the decade to come.
“Major supply chain disruptions during the past decade have mostly not led to any significant changes to supply chain footprints or resilience/risk mitigation strategies, so caution is certainly justified,” said Geraint John, vice president Interos Resilience Lab, which makes supply chain management software. “However, in the case of China and the West, the backdrop is a long-term geopolitical shift in the balance of economic power, rather than merely short-term disruptive events, so unless diplomatic relations begin to improve, it’s highly likely that some strategic rebalancing in supply chains will need to happen.”
“Of course,” John added, “some industry sectors will be impacted by this more than others – critical technologies vs household durables, for example.”
Others maintain that what change comes will be gradual, often citing a ten-year transition period necessary to make meaningful changes. China’s dominance will continue for some time.
“It is a shift,” said Cruz. “I don’t think we’re going to see companies that are completely exiting. You may see 20% to 30% of volume shift over time to new manufacturing countries or completely different geographies.”
“The supply chain is not going away from China,” added Daniel Karlsson, assertively. Karlsson is the managing partner of the consultancy Asia Perspective. “It’s just changing.”
What’s indisputable is that uncertainty and fear over the past two years have reverberated far and wide, from boardrooms to loading docks, storefronts to backrooms, factory floors to legislative chambers. Around the globe, businesses are grappling with what to do with a supply chain system that proved far more vulnerable to widespread disruptions than previously thought.
“Usually, one company or one geographic region has disruption, and we recover. The rest of the system can handle it,” explained Joe Dunlap, who leads the supply chain consultancy practice at CBRE, “But when the pandemic hit, everybody, globally, was completely shut down.”
US–China Trade Dynamic
US-China trade is at the forefront of that unpredictability. “US companies are saying ‘getting everything from China, I got caught with my pants down during COVID, and I don’t want that to happen again,’” said Stanley Chao, managing director of All In Consulting and the author of “Selling to China. “They’re saying ‘I want shorter supply chains. I want local supply chains. I’m willing to pay more money, so when that emergency occurs, I can at least get products. I may only produce 10% now in the US. But when, when I’m in trouble, I can increase capacity from 10% to 30%.”
Even China skeptics concede that wholesale change won’t come overnight. Despite the increasingly harsh rhetoric, US-China trade data, for example, continues to show some consistency. US imports from China in the first half of 2022 actually rose 2% from a year earlier, while US exports to China decreased by 10%.
Just how the global supply chain will be reordered, and what role China will play in it, are also subject to various interpretations. Some tenets, however, are gaining widespread appeal. These include more diversity of sourcing, less emphasis on just-in-time. Near-sourcing and regional supply chains are gaining ground. Cheapest isn’t necessarily the be-all and end-all.
Cruz puts it this way: “There’s a shift in focus from a pure cost-centric mindset to one that balances cost with factors like resilience, responsiveness, responsibility.”
There are changes in China’s own economy to consider as well, as it moves from an export-driven model to one that is focused on its own increasingly affluent, domestic market. “If you look at the aggregate manufacturing in China over the next five to ten years is actually going to get bigger as China’s middle class continues to grow,” said Chao. “Companies are going to make more things in China for the Chinese market.
At the same time, manufacturing in China is also moving steadily upmarket as labor costs increase and manufacturers, engineers, and workers all gain sophistication and expertise. Overall export volume may contract, but value could well expand.
And, then there are political considerations, specifically the contentious relationship between the US and China. Many expected President Biden to slash punitive tariffs that Trump slapped on Chinese goods beginning in 2018; he hasn’t. Trade continues to be weaponized.
As the Inflation Reduction Act demonstrates, certain technologies can be especially vulnerable to political pressures. These can target specific items, such as semiconductors, or individual companies, such as Chinese telecommunications equipment giant Huawei.
Source Diversification: China + 1 or Asia +1
Source diversification is the most obvious result of all this concern. Vietnam is the biggest beneficiary, although other Southeast Asian countries including Malaysia, Thailand and Indonesia are gaining ground as well. Vietnam’s exports to the US for the first half of this year totaled almost $64 billion, a whopping 33% jump over the similar period last year.
Vietnamese factories now produce many of the electronics and other supply chain materials that were formerly sourced in China. “In Vietnam, everything is booming. [Businesses] are moving there and factories are opening,” said Karlsson, who is now based in Ho Chi Minh City. “It’s really a gold rush.”
And, he said, Vietnam is investing heavily in its ports, bringing much needed automation to the process, which speeds up cargo handling.
Karlsson also points out that many of those investing in Vietnamese factories come from Taiwan and China. They want “to get lower labor rates and also be able to export to the US and Europe with the lower duties,” he said.
Add to that the need for redundancy if supply chains are disrupted, a kind of backup location.
This is popularly known as the “China + One” strategy. However, some maintain this diversification is moving further afield. “I don’t think it’s just China Plus One anymore,” said Dunlap. “I think it’s Asia Plus One.”
However, he’s quick to add: “It is not correct to assume that they’re shutting down whatever they have in Asia. The idea is that they’re bifurcating or growing capacity in another region, so they’re insulated to some degree from the next disruption.”
Some industries are taking this one step further, transitioning from a unified, often global supply chain to one that is more regionally based. The automotive industry is leading the way in this. (See sidebar on page 23)
However, Karlsson, Chao and others also maintain that Chinese manufacturing expertise shouldn’t be dismissed or downplayed. Nor should its impressive logistics, both seaside and inland. After all, China has built up a supply chain over more than three decades, with the skilled labor, engineering, equipment, and logistics to go with it.
The more sophisticated the process, the harder it is to simply transfer operations elsewhere. The higher the value, the bigger the stakes, both in terms of return and in terms of investment. “The highly sophisticated things that don’t just require manufacturing, but require some engineering, require development are staying in China,” said Chao. “You cannot just move that stuff over.”
That’s particularly true with near-shoring industries that aren’t already well entrenched in North America, which suffers from a lack of skilled workers.
Karlsson cites a friend who is one of the largest picture frame manufacturers in the world. That person, Karlsson said, decided that plexiglass sourcing would remain in China, but wanted to source the wooden or metal frames themselves in Mexico. “They couldn’t find the supply chain for the frames in Mexico and they’re still struggling,” “It’s easy to come up with these plans in the boardroom, but it’s very, very difficult to execute, because of what China built up.”
Chao offers a similar situation, when he worked with several major Chinese furniture manufacturers who wanted to diversify operations to North America. “We looked at some of the components that are needed for furniture. We couldn’t find it in Mexico. We couldn’t find it in North or South Carolina,” Chao said. “We had to duplicate the whole process.” The solution, he said, was for furniture manufacturers to band together and invest in brand new operations in Vietnam.
“Particularly for industrial-type products, [pre-COVID] American companies were purchasing up to 95%, 100% of their goods, their components, their supplies from China,” said Chao. “They’re looking now to get that 100% down to 80% or that 80% down to 60%.”
However, he stressed, that doesn’t mean the end of a China-dominant supply chain. “You can never bring back 100% of your supply chain from China. It’s too late.”
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