As I hear and discuss the supply chain and “offshoring” strategies of many companies, part of me is surprised at how aggressively it seems many of them are moving headlong into China without looking hard at the mid and long-term supply risks.
Obviously, China offers an incredible opportunity: low costs, very good/excellent quality, outstanding outbound infrastructure, and, of course, a potential domestic market that boggles the mind.
It’s no wonder, as we asked some last year in Is it Global, or is it China?, that the move by western companies to China for manufacturing is incurring at an incredible rate.
Still, I have recently had a few conversations that make me wonder if companies are not taking on too much risk by the mad rush to take advantage of China’s low costs and tantalizing market. Specifically, it seems to me an “over-reliance” on China is very risky given potential dynamics along a number of variables, as I’ll outline below. Nonetheless, I hear from many companies that are not well hedging their bets in the great migration of manufacturing into China.
What are the risks? Seems to me there are three important ones, which I list below, roughly from least to worst:
- Trade war/protectionism: While the move to China can often offer dramatically lower unit costs, the total cost benefit in the end is usually much less than that. The outbreak of any major “trade war” or protectionist barriers that include high tariffs or other cost increases could change the sourcing economics dramatically. Can’t happen? Think again. The odds of major barriers are small – the trade is too important to both sides – there has been a lot of saber rattling lately. A change in the political leadership here, fallout from pressure on wages from Delphi and others (see Delphi, the UAW, and Everyone’s Supply Chain), and other factors could push things over the edge. Former Treasury Secretary Lawrence Summers calls the U.S.-China trade dance a “balance of financial terror.” And while most understand a trade war would be damaging to both sides, “Don’t bet on that logic holding,” The Wall Street Journal recently reported.
- Intellectual Property: Every week, it seems, brings some news of Intellectual Property issues in China. The latest is consumer electronics company NEC, which had dozens of its products virtually cloned by Chinese counterfeiters, down to purchase order paperwork. But that’s just one of many, and not even representative of the real risk, which is having suppliers appropriate designs and IP and become competitors both in China and globally. Cisco, Motorola, GM, and many others have had significant IP issues in China. As manufacturing expertise becomes commoditized, all that’s left is the design and brand – and there’s big risk in moving too much of that offshore with the production.
- Political: Although greatly relaxing most economic freedom, China is still run by Communists, after all. There are two big questions: (1) will growing economic freedom and prosperity eventually lead to political freedom as well, or will at some point the government come down hard on demands for these reforms? (2) What will happen between China and Taiwan, and could rising and falling tensions there potentially lead to actual military conflict, which could drag the U.S. into the fray? Taiwan could at any time elect a leader who raises tensions with China to the boiling point. Either scenario would radically disrupt many supply chains.
Obviously, these risks need to be balanced against both supply and demand side benefits. It’s clear many companies see a potential bonanza in the Chinese market, and believe correctly they need a manufacturing presence there to really capitalize on the opportunity. Companies like Motorola that have invested heavily in China are starting reap significant market rewards – billions in cell phone and related revenue in Motorola’s case.
Still, I think companies committing nearly everything to a China supply strategy need to really look at the whole equation, and find ways to mitigate these risks so that if down the road there are issues, you don’t find your only supply chain strategy is a China strategy.
The global economy will in the end be stronger for everyone if China continues its journey to being a good world citizen. But I’d be hesitant to get in so deep that my company was really at risk if China one day decides to launch a few missiles over towards Taiwan.
In my conversations, I am convinced many companies act as if there is no chance it could happen, and do so at their company’s risk.
Are there real risks associated with trade wars, IP and politics in China, or not to worry? Are companies adequately planning for and considering these risks, or is the rush to China too alluring for many to balance risk reward? How do you get the right balance? Let us know your thoughts.