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Escape from China
How and when to diversify the supply chain
Escape from China, at Velocity
It is high time to high tail it out of China. Or at least this is what consensus opinion would have us believe. Virtually every supply chain manager has received orders from their leaders to decouple immediately, if not sooner. Indeed, with everyone looking for the eject button, it is no wonder that consultant’s pipelines are full of scoping documents to expedite the exodus.
It is not easy to disengage, however, from what we have built—nor is it strategic. Moving quickly and drastically away from China will likely increase costs, consume an inordinate amount of time, and put teams at a disadvantage. Simply put, given the volatile situation it is unclear if divorce is productive.
China’s relationship with the world surely needs a reset—perhaps even couples or group therapy— but a complete breakup is rash and not in anyone’s best interests. Regardless of where this current bout of madness and frenetic activity ends, moving away from China is a decision best made with care and attention to detail.
There are five compelling reasons that suggest China will continue to play an important role in supply and demand chains. First, China has a well-established foundation of human and physical capital. For many categories of finished goods and components, production chains in China continue to offer the best value proposition in terms of total cost, quality, and capacity.
Second, it is not a question of whether to move out of China but more of a nuanced assessment of which pieces and product lines should be sourced elsewhere. About 10 years ago, astute sourcing teams began instituting a China-plus-one strategy, which means maintaining production centers in China plus one other low-cost location. For example, moving high-volume, low mix to SE Asia and keeping low-volume, high-mix in China.
This China-plus-one strategy supports the third reason for the country’s continued critical role in supply chains: it is often on the short list for global design and sourcing headquarters, particularly in FMCG, moderately engineered components, apparel, and electronics.
Product development and sourcing teams based in China have ready access to a vast expert network for rapid prototyping, sampling, tooling development, and all the minutia required to take a product from rough sketch to sales sample. Indeed, these teams are interwoven into the systems and processes that have been satisfying demand from discerning consumer and industrial markets in North America and Europe for the last few decades.
A fourth reason to stay in China is that the supply chain still has significant room for development and productivity improvement. Lean programs, automation, consolidation, digitization, and a whole host of other tools can be leveraged to enhance performance all along the value chain. It is often a useful exercise to answer the question, “What powerful new technologies—like robotics, cloud computing, and artificial intelligence—can boost productivity?”
Finally, domestic demand in China continues to generate new and attractive opportunities. So much so that the absence of a plan to capture demand in China is a breach of fiduciary duty.
Those who consider a shift to SE Asia—Indonesia, Malaysia, Thailand, and Vietnam— as a move away from China will find that they will not have gone far at all. Leading exporters in these regions are interwoven with the bamboo network: they are backed or run by Chinese leadership.
For many of these Chinese-backed exporters, maintaining a rational level of engagement with China—levity in the face of this pandemonium—demonstrates maturity and a sense of perspective. Suppliers are looking for stability and customers that can serve as a ballast in an unpredictable medium-term dynamic likely to be filled with more bombastic rhetoric and geopolitical instability. Suppliers want customers that will not claim force majeure just because they can.
Having said all this in support of China, for some, disengagement will be inevitable either due to cost pressures—China is getting expensive—or the need to build resiliency and diversity in the chain, otherwise known as Supply Chain 101.
SE Asia is often the first port of call and a good place to start. India offers much to consider but continues to disappoint, not for lack of potential but more due to a dearth of leadership and commitment to bring vision to reality.
The medium-term outlook for SE Asia points to strong growth supported by sound fundamentals. For the leaders and constituents of these countries, this moment of maximum negative sentiment towards China presents a remarkable opportunity that will be exploited.
Concerted efforts to build supply chains of scale in SE Asia can yield rewarding results, however, developing these new supply lines poses significant challenges.
First, it is difficult to find suppliers with scale that can easily supplant China. With most suppliers operating new and inexperienced teams, SE Asia presents a rough road that will take five to ten years to pave—with no sure guarantee of success.
Second, supply chains in SE Asia are shallow. Components not available locally will either need to be developed or imported thereby adding upwards of a month or more to lead times versus China where many components will continue to be competitively produced for the foreseeable future.
Moreover, when every link in the chain is less efficient—albeit not drastically—a domino effect is created that demands greater management time and masks hidden costs that appear minor but add up quickly to bloat total costs.
Third, senior management teams are not available or portable across the region. Language and cultural barriers make it difficult to find leadership that can manage across even just two countries. Middle-level management is also in short supply and most lack the experience to operate independently, to be trusted to make judgement calls.
Given all these constraints and “development costs” it is prudent for most companies to expend the effort to select a location that is fit for purpose for the next 10-20 years. Concentrate resources on that one area as spreading yourself too thin across the region is a recipe for disappointment.
Fourth, many SE Asian markets face shortages of skilled and unskilled labor as well as infrastructure. Demand is running ahead of supply, causing inflation across almost all inputs. For example, in Vietnam labor rates increased by nearly 10% in 2020.
All this leads us to conclude that over the medium term it is prudent to consider a three-pronged strategy: 1) China-plus one for low-cost supply; 2) Near shoring; and 3) Sales and distribution focused on capturing demand in Asia.
Said differently, when confronted with the inevitable question, “Are we decoupling from China?”, respond with three questions of your own:
“Do we have a strategy to capture demand in China/Asia?”
“If not, which location can support our supply chain needs for the next 10 years?”
And finally, “Will this location still be better than the US/Eastern Europe/Mexico or other near shoring opportunities in 10 years?”