COMMENTARY: Movement of Supply Chains Out of China Not as Simple as It May Appear

Higher tariffs imposed amid the U.S.-China trade war are only hastening a process pushed by other factors, including rising wages and mounting compliance requirements.

Mark Melnicoe
    Mar 16, 2019 4:35 AM  PT
COMMENTARY: Movement of Supply Chains Out of China Not as Simple as It May Appear
author: Mark Melnicoe   

With companies moving, or at least rethinking, their supply chains, it stands to reason that China is facing very high stakes in the trade war. But, as is virtually always the case in the Middle Kingdom, things are not as simple as they might seem.

That's because China's manufacturing has become so enormous and so complex that the ways in which it's affected by the trade war depends on what's being built and at what stage of the supply line.

Another factor: China's own slowing and evolving economy affects the direction central planners and companies want to go.

Last September, the U.S. slapped 10 percent tariffs on $200 billion of Chinese products. That was on top of tariffs previously imposed on more than $50 billion of goods. China has retaliated and the two countries are in feverish negotiations to stop the escalating trade war.

Despite the new tariffs, it's not easy for manufacturers to just pick up and go somewhere else simply because their products suddenly cost more.

"Most companies cannot afford to consider a wholesale relocation of their factories out of China or replace their Chinese sourcing vendors," said a recent note from consultancy Dezan Shira & Associates. "This is because supply chain infrastructure takes time to establish and China is at the heart of most of the world's production, sourcing, and procurement needs."

Other factors weigh on companies as they consider whether to move some or all of their operations out of China. They include the country's steadily rising labor costs, mounting compliances, social insurance commitments, stringent environmental checks, and other pressures, Dezan notes.

China's Dominance

Despite all these reasons to go, in many cases it likely will pay to stay, particularly for makers of more advanced products.

There is a reason that China makes more than half of the world's electronics. That includes over half of all cell phones and almost all of the world's printed circuit boards (PCBs). Chinese factories also make 40 percent of the world's semiconductor supplies.

In addition to the world-class manufacturing that the country has worked to perfect, China benefits from being in the right neighborhood. The world's biggest cluster of electronics manufacturing lies in East Asia. In addition to mainland China, other big tech hubs include Japan, South Korea, Taiwan, and Singapore.

"Initially assembling products that were designed and manufactured in Japan and South Korea, China has steadily moved up the supply chain with the infusion of technology and capital," Dezan noted. "The country now produces a wide range of goods across the entire electronics manufacturing segment."

That has spawned the emergence of China's first true global companies such as Huawei, Lenovo, and TCL. With much of China's high-tech manufacturing concentrated in the southern province of Guangdong, a big opening has been created for the countries of nearby Southeast Asia. Vietnam has been among the leading beneficiaries of companies shifting their supply lines – in both electronics and lower-tech goods, such as shoes and apparel.

"Of course we welcome that," Nguyen Mai, chairman of Vietnam's Association of Foreign Invested Enterprises, told Caixin in an interview published Friday. "But we hope that foreign investors chose Vietnam not only to avoid the risks of trade war."

But Supply Chain Options Are Rising

In fact, manufacturers have been moving some simpler manufacturing from China to lower-cost countries for quite some time. But the trade war, with its accompanying tariffs, is hastening the process for some.

For Universal Electronics, a maker of television remote controls, the tariffs are simply the latest factor, but it cited other reasons in its Nov. 8 earnings call in which it talked about moving production to its factory in Mexico.

"UEI has developed a supply chain that allows us a broad array of options for addressing manufacturing challenges such as tariffs, labor rate changes, labor shortages, dual sourcing, et cetera," it said.

In general, it is much more difficult to shift advanced manufacturing – a fact acknowledged by the multitudes of firms that are so far staying put in China.

"Higher value-added exports in the machinery, transport and IT category would likely take decades to relocate due to high R&D costs and competitive Chinese labor costs," UBS said in a client note.

So far, it's hard to quantify how much movement is occurring because of the trade war and how much would be happening without it. China is in the middle of a slow but seismic shift, moving toward an economy driven less by cheap manufacturing and instead emphasizing consumption and services. It has also been moving quickly up the value chain as it seeks to compete globally in technology.

Change on the Horizon

All the while, the minimum wage across China is rising quickly. All of this leaves less and less room for industries that rely most heavily on cheap labor.

"We are on the cusp of the biggest sourcing disruption that we have seen in a generation," Stephen Lamar, executive vice-president of the American Apparel & Footwear Association, told Reuters. "The number one thing I hear from companies is along the lines of: ‘For years we have been talking about diversifying from China and now we have to actually do it.'"

Even if all the tariffs come off in a grand deal between President Trump and Chinese President Xi Jinping sometime this spring or later, uncertainty will remain. Questions will linger about implementation and possible backsliding.

And the larger trend that sees the spread of manufacturing to neighboring, lower-cost countries will continue.