Trade & Supply Chain

Question Answered: Supply chain risk in China

Published: Jan 2021

Shipping containers at Hong Kong port

This issue’s question

“To what extent is COVID-19 and the strained US-China relationship is causing companies to rethink their supply chains.”

Portrait of Ker Gibbs, President, The American Chamber of Commerce in Shanghai

Ker Gibbs

President
The American Chamber of Commerce in Shanghai

Some companies are thinking about moving their supply chains out of China, but it is not dramatic. According to our recent survey, only a small number (15%) of US businesses are considering moving some of their production outside of China. Everyone is paying attention to geopolitics, but any shift in supply chains should be seen in the context of rising labour costs and the fact that China is no longer a low-cost producer, rather than rising US China tensions.

For those companies that are moving their supply chain, the top destinations are SE Asia, India and Mexico – the US is way down the list.

However, the issue that jumped out when we asked companies to name their biggest challenge is US China tensions. This tension is particularly hurting companies’ ability to hire and retain staff at their Chinese operations. This is disturbing given that they regularly cite not having the right people to run their businesses on the ground in China as a key challenge.

US companies are more optimistic about doing business in China with a Biden presidency. Under Biden they believe there will be more consistency on policy, and hope that a new administration will be less combative. But people are not naive about the reality of the US China relationship and understand that the underlying issues have not gone away.

There will be a certain amount of decoupling in key areas like the semiconductor sector and dual use military technology as a direct result of policy. It will be increasingly difficult to navigate export controls in key areas wherever technology is concerned. But I believe these areas will remain isolated.

Our members have located in China to serve the Chinese market. They are in China, for China, in a clear distinction from the old model where companies made things in China for export to the world. Today’s supply chains are more complex, and many companies do their final assembly in China using inputs sourced from elsewhere.

We believe our members will continue to invest in their Chinese supply chains. China is the only major market fully open for business – COVID has been controlled and business is quite good. US businesses located in China are feeling more optimistic and are increasing their capacity to take advantage of the consumer market.

One new issue on the agenda is the dual circulation economy. Beijing’s new economic strategy lays out the idea that the country will continue to expand domestic production for exports while also shifting the economy towards a greater relative emphasis on production for domestic consumption. Our members are concerned how Chinese polices could shape the idea of dual circulation, and the role of foreign investment in dual circulation.

Portrait of Jack O'Sullivan, Founder, Modmo.io

Jack O'Sullivan

Founder
Modmo.io

I tried to develop my company from Ireland, but found it was challenging managing the supply chain and production from home. I travelled to Shenzhen in China to meet some factories and suppliers, hoping to make real progress. However, as a small company at the time, we weren’t able to get the meetings with the big factories.

I ended up going to Vietnam to see a motorbike factory. I was so impressed I skipped my flight home and have stayed ever since. It has been three years now. I am currently engrossed in product development and manufacturing in an industrial hub outside Ho Chi Min. I’ve built a fairly big team and we are doing well from Europe’s E-bike boom. Vietnam is less developed, so we are not competing as much to get into the factories. We also got in early. If you are a new company entering Vietnam today, you could struggle to get into the high-tech, high quality factories with a small brand.

Most of our sales are into Germany, Switzerland, the Netherlands and Austria. We employ 16 people in Vietnam today and have produced 1,000 frames so far; we began shipping in December 2020 and aim to produce 1,000 bikes a month from next year.

Around 60% of our parts are sourced from Vietnam, the rest comes from China and Taiwan. We aim to increase this to 100% in the first half of 2021. The majority of the inputs from Vietnam come from within 50km of our factory, and not having to go to China saves us huge amounts of time. The bike’s final assembly and manual processes all take place in a factory in Ho Chi Min that we rent with other manufacturers. We are looking to open our own factory in Q1 next year.

The growth in E-bikes has led to key suppliers of bike parts like rims, saddles and breaks in China and Taiwan stopping taking orders for 2021. Some factories are even saying if you place your order now, you won’t receive it until September 2022. It’s lucky we are in Vietnam. There isn’t as much of a bike industry in Vietnam and so local factories haven’t had the same problems. People are also working hard to convert old factories used in the auto sector to produce bike parts.

Tariffs are another reason for choosing to manufacture in Vietnam. With the European Free Trade Association (EFTA) trade agreement, 99% of tariffs will go to zero over the next six years. That is attractive because there are high tariffs for E-bikes into Europe made in China.

In some ways it’s easier to build a supply chain in China because you can find suppliers through Alibaba – it is a huge marketplace and there is nothing like this in Vietnam. Big companies in Vietnam don’t even have websites. It means finding suppliers involves building your network and attending industry trade shows. Finding high quality factories up to IOS standards is also difficult; finding factories that can produce large quantities of a product is another challenge. Nor do many factories in Vietnam have that much money to invest in their equipment.

Laws are also unclear in Vietnam which makes things challenging. But there is a large and available workforce. Labour costs are also lower than in China, though higher than in Cambodia.

More companies are arriving in Vietnam. The main frame factory we use is doing around four times more business now compared to just six months ago. And Vietnam hasn’t locked down with COVID, so factories have been running the entire time. This has bought a lot of business from China – along with EFTA. The more companies that come here, the easier it will be to do business.

Portrait of Anne Petterd, Partner, Baker & McKenzie

Anne Petterd

Partner
Baker & McKenzie

We have not seen many businesses move their supply chains out of China, but we are seeing businesses increasingly react and ‘sit up’ regarding trade tensions. Assessing the impact of higher tariffs due to trade tensions on inputs to production then becomes a catalyst to review supply chain disruption risks more holistically for the business.

Unsurprisingly, the increased focus on supply chain disruption means that we are seeing more companies making supply chain disruption a board level issue. Other key trends are increased use of data and digital transformation to really understand the risk areas for supply chains and transform supply chains.

It is important to remember supply chain risk doesn’t just include higher tariffs resulting from trade tensions or the impact of the pandemic on procurement. For example, depending on what companies make, the complexity of their supply chains and where they manufacture, their supply chains could have modern slavery risks or face increased regulation around sustainability. The supply chain issues of focus also vary between industries. A particular point of focus for consumer goods businesses in recent times has been both investors and informed consumers demanding to know more about the entire supply chain used to produce a product.

The viability of moving supply chains needs to be assessed, especially if a business has its own manufacturing operations. If a business uses an outsourced manufacturing model, this might give the business more flexibility, but even this can be challenging because there may be significant practical and cost limitations in finding alternate manufacturers.

Many businesses remain heavily dependent on China as a key part of their supply chain. The size and scale of manufacturing in China and related established transportation routes can make finding alternative locations and transportation routes challenging. For businesses seeking to relocate part of their supply chain, often what they do in the current place of manufacturer, they can’t entirely do in another jurisdiction. For example, another jurisdiction might lack the necessary skilled labour or critical inputs.

Achieving the objectives for a supply chain move need to be carefully thought-through. A business might want to move manufacturing or assembly to a new location so as to qualify the goods as ‘made in’ the new jurisdiction under relevant rules of origin. If the inputs to a product are not wholly sourced from a single jurisdiction, the business might need to navigate more complex rules of origin that look at the level of sourcing and effort that can be attributed to that jurisdiction.

Looking longer-term, a critical catalyst to businesses in deciding to move or change their supply chains will be factors like the business’ ability and readiness to utilise robotics and undergo digital transformation as labour comes out of supply chains and more robotics and digitisation goes in. Connected with this, many governments are focused on how they can attract more advanced manufacturing to assist to build up critical mass for new industries.

The past few years have made for a wild ride in trade and supply chains. The many sources of supply chain disruption have introduced a level of uncertainty that businesses have to manage. Supply chain management in the past was often siloed to a particular area within a business. Now it is a whole of business as well as a critical business issue. Recognising this, more businesses are setting up their own supply chain task forces with responsibilities to look at supply chain management risks and strategies across the business.

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