China Plus One Strategy - An Imperative to Achieve Supply Chain Resilience

Over the past few decades, China has emerged as a global manufacturing hub, accounting for approximately 30% of global manufacturing. Chinese manufacturers have developed expertise across domains and strong logistics systems to support international transactions, thanks to factors such as excellent infrastructure, knowledge base, supply chain network, and low labor costs. As a result, many companies relocated their manufacturing to China during the 1990s and 2000s. However, recent developments have led organizations to seek alternatives.

Challenges In China

1. US-China Trade War: The trade war between the US and China, beginning in 2018, led to high tariffs on billions of dollars' worth of Chinese goods and similar retaliatory measures by China. This has made it more expensive for organizations to acquire parts and products and prompted them to seek alternate manufacturing partners.
2. Rising Wages and Labor Costs: As China has transformed into an industrial leader, average wages have increased significantly, leading to labor issues for many overseas companies with manufacturing units in China and prompting them to re-evaluate their setups.
3. Demographic Changes in China: The one-child policy has resulted in an uneven labor pool, with a shrinking number of qualified workers available for the manufacturing industries.
4. Structural Reforms: The "dual circulation strategy" introduced by the Chinese president aims to focus on domestic demand and reduce China's dependence on unfriendly countries, turning China into a self-sufficient economy.
5. Political Risks: Recent political events such as the US-China trade war, instability along the India-China border, and Chinese activity in the East China Sea have impacted how countries do business with China.
6. COVID-19: China's Zero-COVID policy has strained global supply chains due to worker shortages and city lockdowns, emphasizing the need for risk diversification.
7. Technology: China's technological advancements are perceived as a potential threat, with countries excluding Chinese telecom giants like Huawei and ZTE from their 5G trials due to security concerns.
8. Belt and Road Initiative: China aims to gain economic and political influence by integrating itself into global supply chains, leading to calls for supply chain diversification to reduce risk.

The China plus one strategy in the play

China Plus One as a strategy has been explored by many companies, the earliest example of which was during the SARS 2002 epidemic which adversely affected China’s business. Over the past decade, many Japanese companies have been slowly shifting their production to countries like Vietnam, India, Bangladesh and Thailand. International brands have expressed their concerns with the growing cost pressures in China and have therefore already shifted if not completely but most of their production outside of China. For example, a leading cosmetics brand L’oreal has invested approx. US$50 million in its Jakarta plant in Indonesia. Similarly, many other leading apparel brands have also started expanding their sourcing beyond China. Given the current scenario, the tiger cub economies namely Malaysia, Thailand and Vietnam are in a position to reap the benefits of this change where they can supplement the manufacturing operations in China with production units in these regions. India is also in the run-up to becoming one of the key manufacturing partners for companies around the world. A recent survey by the American Chamber of Commerce with over 346 businesses shows that the overall optimism of American business owners in the Chinese economy has fallen by 22% from 2007 to 2020. While in the same period the percentage of business owners willing to reduce their investment in the Chinese market has increased by 22%. 

China is also seeing a downtrend in FDI the country is receiving in the past couple of years. Rising salaries coupled with an uncertain business environment have contributed to the slowdown in investments in the country. Also, due to restrictions on travel and movement, Honeywell’s aerospace business was taking a hit. This prompted the firm to come up with a solution to free up internal working capital to meet its operational costs.

Companies are looking at Southeast Asian countries such as Malaysia, Singapore, Thailand and Vietnam as strong alternatives for FDI for a China Plus One Strategy. Foreign investments are propelled by Free Trade Agreements which enable a country’s economic growth and improve intellectual and social life while having a positive influence on the business environment.

These Southeast Asian economies have invested in several free trade agreements to strengthen their position as a contender for China Plus One. Vietnam is focusing on establishing itself in the low-tech electronic manufacturing and IT industry and has secured deals from industry leaders such as Samsung and Intel. Along with textiles, Malaysia is looking at the electrical and electronics industry, Thailand for electronics and automotive manufacturing and Indonesia for the information and communication industry. Concurrently India also has been tapping into the opportunity of the China Plus One diversification trend. India has already reaped benefits in sectors such as machinery and consumer goods. Indian governments’ flagship initiatives namely Make In India, Digital India and Atmanirbhar India coupled with a promising demographic dividend are acting as a driving force in positioning India as one of the strongest global players.

Benefits of the China plus one strategy

1. Risk Diversification – Having production spread across several countries makes companies less susceptible to problems and shields them from supply chain disruptions caused due to issues such as tariffs, currency fluctuations, tax policies, wages and political uncertainties.
2. Opportunities to lower costs -  As discussed earlier, China is no longer considered a low-cost labour market for several products and services. The shortage of skilled workforce coupled with wage issues is making China lose its cost advantage. In response to this companies are setting up manufacturing in countries with lower labour costs. For example, Hanes brands a leading undergarments manufacturer has set up a minimally automated plant in Vietnam and two in Thailand owing to lower labour costs whilst they have a heavily automated factory in Nanjing, China. Lower cost benefits can also be realised by moving manufacturing in closer proximity to the final markets which companies are coming to realise.
3. Knowledge transfer – The diversification strategy offers scope for learning from new markets for organizations and using their core competencies for growth prospects. Companies can utilize their experience in transferring knowledge to the partnering economies where they can grow beyond merely a production location.
4. Access to new markets – Having a burgeoning middle class offers a great opportunity for companies to manufacture and sell their products. Where China was once seen as just a low-cost production site has evolved into one of the important markets in the world, likewise, the alternate Plus-One countries can be seen beyond just diversification or cost-saving strategies to penetration into the next group of emerging markets.

Adoption of China plus one strategy by Apple Inc.

Apple Inc. leading tech giant in an attempt to minimise its reliance on China is slowly shifting its device assembly processes to factories in India and Vietnam. Both India and Vietnam seem to be becoming important parties in the global value chain. Currently, Apple manufactures about 90% of their devices such as iPhones, iPads and MacBooks in China. But, given the recent geopolitical trends, China’s policies combined with the pandemic have pushed Apple to diversify its supply chains to other countries to de-risk its heavy dependence on China. Apple has been assembling their products in both India and Vietnam for a few years and aims to leverage its presence in these countries and increase its volume of production to meet global demands.

A forecast by JP Morgan states that the percentage of Apple products made in China will drop from 95% to 75% by 2025. Given the product category, Apple aims to move 20% of iPad, 5% of MacBooks, 20% of watches and 65% of Air Pods to be manufactured in Vietnam.

Reasons for Apple to relocate from China

1. High tariffs as a result of escalating geopolitical tensions between the US and China have played a key role in considering alternate destinations for manufacturing.
2. China’s zero covid strategy-induced lockdowns squeezed supply chains causing heavy disruptions in manufacturing
3. Recent announcement by the US administration for an investment of $50 billion for building semiconductor plants in the US to cut down dependency on China.

Apple's China plus one solution

Several key contract manufacturers for Apple such as Foxconn, Pegatron, Luxshare and Wistron have expanded their production facilities in Vietnam as Apple is moving out of China. Foxconn corporation has leased 50.5 hectares of land to build a new factory in Bac Giang Industrial Park Joint Stock Company, Saigon, Vietnam which is expected to provide jobs for 30,000 workers.

Around June, Apple moved its iPad production to Vietnam from China and started manufacturing watches and MacBooks in August. While in India, Foxconn started producing the iPhone14 within 3 weeks after its launch which is the shortest manufacturing gap. Around October, Apple asked its suppliers to move the production of headphones Beats and AirPods to India shortly. Apple has increased its supplier’s facilities in Vietnam from 14 in 2018 to 22 in recent times.

Conclusion

Although China seems to be struggling with many issues such as geopolitical standpoint, Covid 19, rising wages and an ageing workforce in recent times, it is important to note that companies cannot completely uproot their operations from China as they still have a very strong supply chain network, infrastructure and knowledge base here. Instead, organizations are looking for suitable alternatives that will help them to reduce their risks and have more resilient supply chains. For example, Intel has opened a new facility in Vietnam but still, they have important assets in China. Similarly, for Apple, It might take 8 years for them to move only 10% of production away from China. Organizations are aware that there is no single country that has the capabilities of China to replace it as the global manufacturing powerhouse. Over the years Chinese suppliers have developed the skills and know-how to provide the desired output as a well-oiled machine. It would be foolish for organizations to underestimate the ease of relocating manufacturing to other locations and not to consider the supply chain sunk costs in this activity.  Therefore, the relocation activity can happen only in a fragmented manner. Therefore, using the China Plus One Strategy, organizations are trying to reduce their dependency on China as a single source of supply and move the production of certain products to other countries considering their core competencies and comparative advantage. This provides a golden key to the neighbouring countries that can benefit by increased utilization of resources leading to greater socio–economic impact. In the long run, China Plus One strategy only aims to achieve the best of both worlds for organizations which is strategic diversification to de-risk supply chains while continuing their involvement in one of the world’s biggest markets.

References

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