Market Insights

Evaluating the Rationale and Challenges of Shifting Supply Chains from China to Southeast Asia

Factory workers in Thailand

The global landscape of supply chains is undergoing a significant transformation as companies increasingly shift their manufacturing bases from China to Southeast Asia. This strategic move is driven by a confluence of economic, political, and operational factors. While China has long been the world’s manufacturing hub, rising costs, geopolitical tensions, and the need for supply chain diversification are prompting businesses to explore alternative locations. Southeast Asia, with its competitive labor costs, improving infrastructure, and favorable governmental policies, is emerging as a preferred destination. However, this transition is not without challenges. This article explores the rationale behind this shift, identifies the associated risks, and provides strategic recommendations for businesses navigating this complex landscape.

Competitive factory labor costs in Southeast Asia

Graph showing Average Salaries of Factory Workers in 2023 (US$)

One of the primary economic drivers for relocating supply chains from China to Southeast Asia is the rising cost of production in China. Over the past few decades, China has experienced significant economic growth, leading to increased labor costs. This has eroded the cost advantage that once made China an attractive manufacturing destination​. Southeast Asian countries like Vietnam, Malaysia, and Thailand offer much lower labor costs, making them more attractive for labor-intensive manufacturing operations.

Geopolitical tensions affect sourcing strategy of Multinational Corporations

Chart showing US and EU-Based Brands’ Sourcing Portfolios

Geopolitical tensions, particularly the US-China trade war, have significantly impacted global supply chains. The imposition of tariffs and trade barriers has increased the cost of doing business in China for many US-based companies. This has accelerated the shift of supply chains to Southeast Asia, where trade relations with the US are more favorable​​.

Furthermore, Southeast Asian countries are actively courting foreign investment by offering various incentives. Governments in countries like Vietnam and Thailand have implemented policies to create a favorable investment climate, reducing bureaucratic hurdles and offering tax incentives to foreign companies​. ASEAN countries compete for best practices in FDI friendly policies Although holding diversified political regime, most ASEAN countries have shared knowledge in economic development. The tried-and-tested export-oriented strategy has been passed on from Singapore to ASEAN-4 (Malaysia, Thailand, Indonesia and the Philippines) and to CLMV (Cambodia, Laos, Myanmar and Vietnam). To attract FDIs, governments normally establish free trade zones, invest in infrastructure development and human capital including education and vocational training.

Diversifying supply chains outside of China to mitigate risks

From an operational perspective, companies are seeking to diversify their supply chains to mitigate risks. The COVID-19 pandemic highlighted the vulnerabilities of having a concentrated supply chain in one region, prompting companies to establish manufacturing bases in multiple locations to reduce the risk of disruptions.

In response to rising costs in China, multinational corporations (MNCs) are exploring different ASEAN countries to diversify their competitive advantages. For instance, to adapt to high-tech decoupling, chip companies have increased their investments mainly in the Singapore-Malaysia-Indonesia triangle. During chip fabrication shortages caused by the coronavirus pandemic, American companies Global Foundries and Micron, Germany’s Infineon and Siltronic, and Taiwan’s Semiconductor Manufacturing Company rapidly expanded their presence in these countries.

Conversely, to reduce production costs, other leading firms have moved operations to CLMV (Cambodia, Laos, Myanmar, and Vietnam), closely followed by their supply chains to maintain spatial proximity. For example, Taiwanese company Foxconn and Chinese CoreTek, major electronics manufacturing services providers for Apple, are relocating to Vietnam.

Key challenges should be considered ahead

Graph showing the gap of output (GDP, in USD) per worker

Labor and Skill Gaps

While labor costs are lower in Southeast Asia, there are challenges related to the availability of skilled labor, which can affect productivity and quality, especially in high-tech manufacturing sectors. Companies may need to invest in training and development programs to enhance the skills of the local workforce.

Moreover, Southeast Asian countries generally lag China in terms of output per worker. Considering China’s substantial investments in factory automation, catching up in this regard remains uncertain for Southeast Asia in the near term. However, it’s important to recognize the significant strides Southeast Asia is making in enhancing its workforce productivity and adopting automation technologies, which could gradually close this gap.

Infrastructure Limitations

While infrastructure development in Southeast Asia shows progress, it remains less advanced compared to China in key areas. Evidence of this disparity can be seen in varying transportation networks and port facilities across countries like Vietnam and Indonesia, which do not yet match the scale and efficiency of those in China. Inconsistent infrastructure quality can create logistical hurdles that impact supply chain operations. Nevertheless, ongoing investments and initiatives aimed at upgrading infrastructure in these regions highlight their potential to overcome these challenges and improve supply chain efficiency in the future.

Even though Southeast Asia still has some gaps compared to China in terms of labor and infrastructure development, which will take time to close, the countries in this region are already increasing their investments. This includes substantial funding for labor training programs to enhance workforce skills and the construction of essential infrastructure such as railways, ports, and highways. These improvements are significantly supported by foreign companies. Many multinational corporations are investing in Southeast Asia, attracted by its strategic location and growing markets. In the long term, these improvements not only boost Southeast Asia’s economic growth but also provide multinational corporations with a viable alternative to China, diversifying their supply chains and mitigating risks associated with over-reliance on a single country.

Our practices in shifting supply chains support

Case study illustration

Our client, a major manufacturer in the automotive industry, sought to diversify its supplier base beyond China to Southeast Asian countries like Thailand, Vietnam, and Malaysia. ARC Consulting was engaged to facilitate this strategic shift by identifying potential suppliers capable of producing high-quality rubber and metal automotive components for their Chassis and Powertrain divisions.

Our approach began with comprehensive data gathering and analysis within the target regions to map out the supplier landscape. This involved not only assessing cost-effectiveness but also prioritizing quality standards, reliability, and ethical practices. By developing a robust supplier evaluation framework, we ensured that our recommendations aligned with the client’s strategic goals of forging sustainable, long-term partnerships.

The impact of our efforts was tangible and immediate. We presented the client with a curated list of 14 suppliers offering significant cost-saving opportunities, typically ranging from 15% to 20%. Furthermore, we provided detailed insights into the capabilities and strengths of suppliers specializing in rubber and metal automotive components across Vietnam, Thailand, and Malaysia. Following successful introduction meetings and rigorous sample testing, the client swiftly identified suitable alternative suppliers and commenced business operations, thereby diversifying and strengthening their supply chain network.

ARC Consulting’s strategic approach not only enabled our client to achieve substantial cost efficiencies but also enhanced their resilience through geographic diversification of suppliers. By emphasizing quality, reliability, and ethical considerations in supplier selection, we facilitated a smoother transition towards establishing robust, long-lasting partnerships in Southeast Asia’s burgeoning automotive component market.

Strategic considerations before decision-making

Table of supply chain shift recommendationsBefore relocating supply chains, companies must conduct a thorough risk assessment to identify regulatory, political, and operational risks in target countries, focusing on legal frameworks, labor market conditions, and infrastructure capabilities. They should establish clear selection criteria for new locations, considering cost, proximity to key markets, availability of raw materials, and political stability. Detailed financial planning is essential to ensure cost-effectiveness, including budgeting for infrastructure development, training programs, and regulatory compliance.

Companies should adopt phased transition plans to manage risks and ensure business continuity, starting with non-critical operations. Forming local partnerships can facilitate adaptation and improve efficiency, while investing in training programs helps bridge skill gaps. Continuous monitoring and evaluation of new operations are necessary to maintain performance and quality standards. Flexibility and adaptability are crucial to respond to regulatory or market changes. Enhancing local supply chain resilience through multiple supplier relationships and contingency plans ensures steady material flow and mitigates disruptions.

Relocating supply chains from China to Southeast Asia is a crucial yet intricate step for many companies aiming to cut costs, spread risks, and improve operational efficiency. Despite the challenges such as infrastructure constraints, and disparities in labor skills compared to China, meticulous planning and implementation can help businesses overcome these obstacles. By capitalizing on Southeast Asia’s economic, political, and operational strengths, companies can strategically position themselves for sustained success in global manufacturing. Looking ahead, the trend of supply chain reallocation is expected to continue as business seek greater continuously monitor regional developments, invest in local talent, and leverage technological advancements to enhance the operations. This proactive approach will enable businesses to adapt to evolving market dynamics and maintain a competitive edge in the global economy.

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