Don’t overlook China for manufacturing outsourcing because of COVID-19 supply chain disruption

The world’s manufacturing activities have taken a big hit from COVID-19. The outbreak of the disease in China and its subsequent spread to Europe and North America have forced manufacturers to shut down their manufacturing activities across industries. The leading manufacturing hub of the world, China, which accounted for 28% of global manufacturing output in 2018, according to data published by the United Nations Statistics Division, as shown in Exhibit 1, has been severely affected by the pandemic. As a result, enterprises around the globe are facing massive supply issues. So, a big question is brewing for the enterprises about whether it’s time to shift manufacturing operations from China. In this PoV, we explore the current challenges and competition China faces and analyze why China will remain the largest global manufacturing hub in the near to medium term. This PoV acts as guidelines for enterprises making decisions about diversifying their manufacturing operations from China.

Exhibit 1: China is the largest manufacturing hub in the world

Increasingly frequent disruptive events make supply chain risk management a high priority for enterprises

As disruptive events (trade wars, natural calamities, pandemic, etc.) become frequent, supply chain disruption mitigation will be a part of mainstream supply chain planning for enterprises. As a part of that, enterprises have plans to encourage local manufacturing (though the volume will be less, Industry 4.0 principles can be the enablers to achieve the cost efficiency) and to shift at least part of their manufacturing base from China to other low-cost countries, reducing the overall risk of the supply chain.

New manufacturing destinations could become heavy competition for China

Some of the other countries are positioning themselves as alternate manufacturing destinations. Recently, Vietnam has become one of the preferred destinations for manufacturing due to the US-China trade war. Mexico exports automotive goods, electronics items, and other products to the US. Some European countries, such as Romania and the Czech Republic, also have a manufacturing heritage. Manufacturers consider India a favorite manufacturing destination. Manufacturers need to control variables such as quality management, safety and security, and labor-management issues to scale manufacturing activities in these locations. Though these locations look promising, most of these locations have narrow experience in specific industries and would need more guidance for manufacturing across sectors as China does.

Why will it be challenging to replace China in the next five years (i.e. in near to mid-term)?

We have identified some of the critical factors that both favor China as a manufacturing destination and show while it will take a long time for other countries to reach this level of manufacturing agility:

• Ecosystem presence: China is a manufacturing hub for automobiles, heavy manufacturing, chemicals, and high-tech industries. To feed these large manufacturing operations, China has a long tail of suppliers, creating an ecosystem of many small and large players across industries. Also, China has a significant repository of several natural resources.
• Government support: China’s government has created a favorable environment for manufacturing, and it has made significant investments in infrastructure, such as ports and roads.
• Presence of mammoth enterprises: China has the highest number of companies (a total of 129, including 10 from Taiwan) in the Fortune Global 500 list in 2019. Though for many of these companies, the major revenue comes from the internal market, some companies like SAIC Motor and Huawei have a good international presence. As a result, China has developed a global perspective across industries.
• Trusted contract manufacturers: Through trade fairs and other forums, China’s government has taken a structured step to highlight top contract manufacturers in each sector. These contract manufacturing companies can manage end-to-end manufacturing operations, including quality certifications and precision engineering.
• Long tail of suppliers: Many Tier 1 and Tier 2 suppliers for Mexico and Eastern European countries depend on Chinese suppliers for manufacturing. The worldwide dependency on China is much deeper than you might expect.
• Production efficiency: China adopts modern technologies quickly and has a well-trained workforce, so the overall production efficiency is quite high. Also, China has faced little to no labor trouble in the past.
• Trade uncertainty: Large enterprises are worried about the ongoing trade war between the US and China. But there are also other events, such as Brexit (uncertainty over free trade movement between the UK and EU countries) and apprehensions about NAFTA (impact on the trade relationship among the US, Canada, and Mexico), affecting the global supply chain. Trade uncertainty is not limited to China—it is becoming a common concern.

China also needs to improve on certain aspects

There have been several allegations and complaints against China in different areas of trading over the years. We believe that China needs to improve on certain aspects to stabilize its relationships with the rest of the world.

• Trade disputes: Some countries have complained about China regarding intellectual property laws and subsidies on certain commodities. Though this type of dispute is not uncommon in international trade, the allegations against China have been frequent in the past.
• Currency manipulation: Several countries have complained about China influencing exchange rates to increase exports. They mention that China deliberately devalues its currency to increase export competitiveness.
• Environmental impact: As large enterprises worldwide are committing to sustainability goals, including green supply chain and ethical sourcing, China needs to realign itself with sustainable goals and practices.
• Food safety and healthcare measures: In the light of this COVID-19 outbreak, China needs to focus more on its food supply chain (strict regulations around food safety) and its healthcare system (to stop this type of disease in the very early phase).

The Bottom Line: Do not forget China completely for manufacturing outsourcing in the near to medium term—the alternate destinations are not ready yet.

Post COVID-19, the mandate for the enterprises will be to manage the supply chain risk management, and, as a result, they can shift some of their manufacturing operations to alternate locations in the near to medium term. Enterprises will be in observation mode to stabilize manufacturing in these new locations before scaling up. We conclude that China will remain the biggest manufacturing hub in the near and medium term, but in the long term, we expect a combination of countries, such as Vietnam, Mexico, India, and Romania, to become the first manufacturing location choice for enterprises.