China is often described as the workshop of the world given the global reliance on its workforce to mass-produce products at low cost.
But the “Made in China” label has come at a higher price for some multinational companies in recent years. Labor costs are climbing as more Chinese workers demand better pay and benefits amid the country’s increasing economic prosperity. That has more manufacturers developing a so-called “China plus one” strategy, which is to diversify production into cheaper Asian countries such as Vietnam, Thailand and India.
“The companies that have gone to China simply for low cost are now finding that China is relatively more expensive, so they are going to other countries where costs are lower,” says Jayson Myers, president and chief executive of the Canadian Manufacturers & Exporters (CME) trade and industry association.
This includes manufacturers of high volumes of consumer products such as clothes, shoes, auto parts and electronics. Multinational companies such as Nike, Ford and Intel aren’t abandoning China altogether, especially given the complexities of moving such large-scale operations. Still, many are choosing to reduce their dependence on the country by adding in a lower-cost Asian economy to their manufacturing portfolios. Diversification also isn’t just about costs either. Some companies want to spread political and geographic risks that could impact costs, everything from changes in government regulations and taxes to natural disasters.
According to a survey of key global trade management players in East Asia that was conducted by Thomson Reuters ONESOURCE and KPMG, almost two-fifths said that risk avoidance was the area where global trade management could best enhance its value to the company, while almost a quarter pointed at cost savings.
While this shift should be considered a blow for China’s economic growth, which has been slowing in recent years, experts say the transition is part of a healthy shift in the country’s manufacturing sector. It’s helping China make a much-needed move towards more value-added manufacturing processes with more sophisticated tools and technology, and to develop higher-skilled workforce.
“Manufacturing has become a bit of a curse for China,” says Daniel Trefler, a professor of business economics at the University of Toronto’s Rotman School of Management.
Trefler argues China’s economic policy has been dominated by manufacturing interests, which needs to change if the country wants to open up its economy to the world and become the world’s largest economy (up from second place today, behind the United States).
“The change is good for China because it’s telling them that they can no longer be low-wage competitors. They have to start to become more innovation-based competitors,” Trefler says.
Forecasted hourly manufacturing wages in China
Forecasted unit labor costs in China
Taneli Ruda, senior vice president and managing director of Thomson Reuters ONESOURCE, describes China’s manufacturing shift as “part of a natural transition for an economy that is moving into higher value added, higher GDP per capita model.”
He notes countries such as Japan and South Korea underwent similar shifts year ago, albeit at a much smaller scale.
Opportunities for other Asian nations
The diversification away from China also creates huge opportunities for Southeast Asian countries such as Vietnam, Malaysia, Indonesia as well as India, Ruda says. Many of these nations have been proactive in trying to lure business away from China through tax incentives, as well as partnering with multinational companies to build infrastructure to help smooth out logistics across the supply chain.
Industrial manufacturing production picking up steam in Southeast Asia
Ruda points to the aggressive “Make In India” campaign being pushed by Indian Prime Minister Narendra Modi, which is a play to boost its manufacturing base. General Motors recently announced it was doubling its commitment in India through a $1-billion investment to make Chevrolet vehicles in the country, and cited the “Make in India” government program. GM says the market for passenger vehicles in India is expected to expand to about eight million units by 2025.
“We intend to be part of the growth,” said Phil Kienle, vice-president manufacturing for GM International Operations and GM China in an email. He said the goal of the India investment is to double its market share and establish India as an export hub. “We see significant opportunity in India and we believe it is critical that we position. GM for sustained success in India, both for the domestic market and for export markets.”
In 2013, GM decided to spin off its international business into separate entities: GM China and GM International. It said the separate GM International business was done to focus on markets in the Middle East, Africa, India, Southeast Asia, Korea and Australia. The company said its global growth markets strategy includes investing $5 billion to develop an all-new vehicle family “to meet the rapidly changing demands of customers” in countries such as India, as well as Brazil, China and Mexico. GM also has a major manufacturing presence in Korea. Its GM Korea division produced 1.65 million vehicles for 140 markets worldwide in 2014.
“GM remains confident in the long-term potential of Southeast Asia, “said Kienle, noting the region has more than 600 million people. However, he said that Southeast Asia doesn’t behave as one economy and that local regulations “make it very difficult and costly to build a vehicle in one ASEAN country and export it to another. So it is very difficult to achieve scale.”
“At GM, we take decisions to invest our capital where the opportunity for growth is greatest,” said Kienle, “The company’s investment in China continues to perform strongly. As we look to position the company for further growth into the future, it is critical that we participate in growth markets like India, which has both the domestic scale and the potential for exports that can allow us to achieve scale.”
Don’t count China out
China isn’t sitting idly by as the landscape changes, even if a move towards more higher-value manufacturing in the country is needed. China has developed its own “New Silk Road strategy,” which is a set of trade and infrastructure agreements meant to foster free trade with its neighbors.
Ruda says China is also guiding a manufacturing shift from the higher-cost coastal region into the lower-cost interior parts of the country, which hasn’t seen the same level of economic development to date. It’s also working to better train its workforce, catering to companies seeking more skilled workers.
Myers of the CME says companies are still doing business in China because they see the benefit of operating in the country. Many are partnering with Chinese companies to help them sell into the local market as it shifts its focus towards a consumer driven economy and away from one focussed heavily on infrastructure spending.
A growing Chinese middle class also means more potential customers for companies selling in the country.
“That’s the type of company that will stay in China, rather than move their production offshore simply because it’s lower cost,” Myers says.