Geopolitical Tensions and Supply Chain Risks Drive “China Plus One” Strategy
In the ever-evolving landscape of global economics, China, once the beacon of opportunity for Western businesses, finds itself facing a transformation. Despite its status as the world’s second-largest economy and a manufacturing giant, various factors are now causing Western companies to reassess certain aspects of their operations in China.
China’s once substantial economic growth and large market size, which initially attracted multinational enterprises (MNEs), are now declining. Labor costs surged notably between 1993 and 2015, making China less attractive for low-skilled manufacturing compared to other Asian countries. Governance uncertainties, stemming from abrupt policy changes and the zero-COVID strategy, has hindered many MNEs from deploying and retaining foreign staff in China, impacting the long-term viability of foreign subsidiaries. Concerns over dependence on Chinese sourcing emerged around 2010, and the disruptive impact of COVID-19 from 2020 onward has further accelerated these strategic shifts.
In recent decades, foreign businesses operating in or having connections to China, particularly those from the US and Europe, have taken strategic measures due to escalating geopolitical tensions and supply chain vulnerabilities. This has led to the formulation and acceleration of the so called “China Plus One” strategy and a broader decoupling trend. Decoupling from China refers to the strategic process undertaken by some countries or companies to reduce their economic interdependence with China, often in response to geopolitical tensions, supply chain vulnerabilities, or other concerns. Moreover, the “China Plus One” strategy involves diversifying manufacturing or sourcing operations by maintaining a presence in China while simultaneously expanding into other countries to mitigate risks associated with full dependence on China’s market or supply chain.
Notably, surveys from the American Chamber of Commerce in China over the past years indicate that approximately 40% of US companies have relocated or are considering moving manufacturing facilities out of China. In line with this trend, the ARC Consulting’s Sourcing Survey 2023 notes that although China remains a significant sourcing market, approximately 30% of respondents intend to relocate portions of their sourcing in the coming year. Additionally, Japan is incentivizing companies to bring production home or shift to Southeast Asia, while the EU is reviewing its trade policy to address supply chain restructuring.
Decoupling Decisions Impacted by Strategic Importance and Reshoreability
Initially, the expected increase in companies decoupling from China because of political factors will differ among industries. This difference will mainly depend on two important factors: strategic importance and the ability to bring production back to the home country, also known as reshorability. Strategic importance often refers to the national-level significance of the industry, taking into account broader concepts of national security amongst other factors.
Industries deemed highly strategically important are more likely to relocate production away from China, driven by political pressures to safeguard crucial products and knowledge from a potential adversary. In cases where reshorability is high, firms may opt for reshoring to their home market. In contrast, where reshorability is low, companies may pursue friend-shoring, relocating to allied countries.
Low strategic importance industries are less likely to apply a decoupling strategy. If reshorability is low, production may persist in cost-competitive countries, regardless of political alignment. In contrast, industries with low strategic importance and high reshorability have the option of both offshoring and reshoring, driven by cost and supply chain considerations.
Understanding and navigating these dynamics will be crucial for businesses to decide on what suits most amid the evolving landscape.
Great Uncoupling: Distinct Supply Chains for China and the World
In response to evolving challenges, companies are proactively diversifying their sourcing away from China, with the COVID-19 pandemic prompting a shift from supply chain efficiency to resilience. This strategic shift signifies a departure from a sole focus on supply chain efficiency towards a broader goal of increased responsiveness and risk reduction.
For instance, German car manufacturer BMW has expanded operations in Vietnam, a country that offers competitive labor costs and has been attracting foreign direct investment due to its political stability and strategic location. Similarly, parts of Swedish furniture giant IKEA’s retail industry is diversifying its sourcing by increasing procurement from India, aligning with sustainability objectives while reducing dependency on China. Uniqlo, a key player in the clothing and footwear industry, has also unveiled plans to shift production from China to Southeast Asia and India, capitalizing on cost advantages in these regions and reinforcing business resilience.
This proactive restructuring of supply chains reflects an emerging trend known as the “great uncoupling”; wherein foreign businesses are strategically adopting a dual-track approach. By establishing distinct supply chains for China and the rest of the world, companies are fortifying their capacity to navigate the dynamic global landscape effectively. This strategic shift applies to various industries, highlighting a trend that business leaders should follow to strengthen their companies against ongoing uncertainties.
Rising Stars: Southeast Asia and India
In the quest for robust alternatives to China, Southeast Asia countries and India have emerged as rising stars in the “China Plus One” strategy of Western companies looking to diversify supply chains. Within Southeast Asia, Vietnam, Thailand, Indonesia and Malaysia have gained significant traction as promising destinations.
Each option presents distinct considerations, contributing to a nuanced understanding of the strategic landscape:
Vietnam: Boasting a cost-competitive manufacturing hub with skilled labor and favorable Free Trade Agreements (FTAs), complemented by its strategic location in Southeast Asia, Vietnam is particularly advantageous for industries such as electronics, textiles, footwear, and furniture. While infrastructure challenges exist, ongoing government investments are addressing these issues, making it a dynamic and evolving market.
Thailand: Positioned strategically with robust infrastructure and a skilled workforce, Thailand is an attractive option for industries like automotive, electronics, food processing, and more. Its well-established logistics and transport networks enhance its appeal, and proactive government initiatives continue to drive economic stability despite occasional political instability.
Indonesia: With access to a growing consumer market and abundant natural resources, Indonesia presents lucrative opportunities in sectors such as agriculture, automotive, mining and consumer goods. While the government’s commitment to infrastructure development, including the “Making Indonesia 4.0” initiative, fosters a business-friendly environment, businesses need to address challenges related to infrastructure gaps and regulatory complexities.
Malaysia: Renowned for advanced manufacturing capabilities, especially in electronics, medical equipment, and aerospace, Malaysia provides a stable political environment and proximity to global shipping routes. Its location in Southeast Asia offers easy access to regional markets. However, challenges such as a skilled labor shortage and relatively higher operational costs should be navigated strategically.
India: Emerging as a potential powerhouse with a vast domestic market, India aligns strategically with the interests of the US and EU. While industries like IT hardware and services, electronics, pharmaceuticals, and renewable energy find promising opportunities, businesses must navigate a complex regulatory environment and address infrastructure challenges for successful ventures.
As companies seek alternatives to China, Southeast Asia and India have emerged as pivotal players in the “China Plus One” strategy. Each market offers unique advantages and challenges for diversifying supply chains. From Vietnam’s cost-competitive manufacturing hub to India’s vast domestic market potential, businesses must carefully weigh factors such as infrastructure, regulatory environments, and market accessibility in their strategic decision-making process. By selecting from this diverse array of options, companies can mitigate risks while capitalizing on the promising opportunities these regions present, ultimately fostering sustainable growth and resilience in their supply chain strategies.
Choosing “Plus One”: Business Trade-Offs and Long-Term Commitment
In the “China Plus One” strategy, a dual-track approach is employed, requiring careful consideration of various factors such as the business environment, political stability, labor expenses, trade regulations, and the presence of proficient workers when selecting the “Plus One” country. This approach demands careful considerations of business trade-offs.
Building a competitive manufacturing and sourcing footprint requires a comprehensive approach. Untangling supply chains developed over decades is a multifaceted challenge, involving the establishment of new supplier relationships, adaptation to diverse regulatory environments, and potential quality control issues. Additional key considerations include the decision-making processes guiding decoupling, the sequencing of functions relocation, and effective capital and knowledge transfers, among other crucial factors.
In-depth market research plays a crucial role, guiding executives to evaluate alternative locations based on factors like market potential, infrastructure, regulatory environments, and labor costs, ensuring alignment with overarching business objectives.
Additionally, supply chain analysis, cost-benefit analysis, and considerations of legal, regulatory, political, and cultural factors are pivotal. A comprehensive risk management plan, developed in collaboration with experts and local entities, can position businesses for sustained growth and resilience on the global stage
Looking Beyond “China Plus One”
Navigating the process of decoupling from China is an ongoing and often complex process for foreign businesses, shaped by a multitude of factors. The “China Plus One” strategy is a long-term commitment requiring strategic vision and a forward-thinking approach. Anticipating the future, companies may explore progression to a “China Plus Two” or “China Plus Many” strategy to enhance resilience and flexibility, recognizing that such a shift introduces additional complexity.
Successful implementation of the “China Plus One” strategy requires not only diligent planning but also strategic decision-making and a capacity for adapting to the nuances of managing global operations. Businesses must account for shifts in the global trade landscape and potential economic and political fluctuations across different countries.
Throughout this strategic transition, specialized expertise from local partners can prove invaluable, assisting businesses in formulating and executing a robust “China Plus One” strategy tailored to their unique needs and goals.
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