October 26, 2013 Survey Says: What Are My Options Beyond China?

Volume 16 | Issue 9

For years, when manufacturers worldwide contemplated opening or moving operations offshore, only one country, China, came to mind. With all

Chinese manual labor is not quite so cheap anymore. Real estate costs are up. And many of the other business incentives the country once had are either gone or deteriorating fast. Is China’s dominating role in global manufacturing in jeopardy? Yes and no, Leo Rommel reports.

Josh Timberlake has been in this business for quite some time, the entire time in a practice that focuses on global location strategy and site selection. And, predictably, one of the most common questions his practice specializes in answering is: Where should my company build their next manufacturing plant? The answer used to be nearly unanimous.

“We went through a long stretch of time, going back to the mid-2000’s, where the default answer for that question was usually China,” he recalls. “Whether it was a U.S. company or a Western European company, most of them looked at China as the ideal place where products were manufactured economically and easily.”

And, truth be told, that was unquestionably the case, for more than a number of years actually. Perhaps too long, depending on whom you speak with.

But times are changing, he adds. The aforementioned question still gets asked. That part hasn’t changed. But its answer, at least on a number of occasions, has. And if China still wins, it’s only after manufacturers have first considered alternative options.

Simply put, China is no longer the foregone choice for offshore manufacturing. Timberlake has proof. His firm has done extensive research on it.

Timberlake, Senior Manager in Deloitte Consulting LLP’s Real Estate & Location Strategy practice, is the coauthor of “Manufacturing beyond China,” a white paper that discusses how more and more manufacturing clients are exploring alternatives to China for deployment of new capacity.

A number of reasons are triggering the movement, Timberlake tells Industry Today. They include but are not limited to rising production costs, escalating wages, increasing competition for talent, intellectual property risk, dwindling government incentives, and the growing desire to shorten supply chains. As a result, export-oriented manufacturers worldwide are exploring other well-known or quickly-developing production locations to set up shop in, most commonly in other Asian markets.

And it’s not just American manufacturers jumping on this bandwagon. “We continue to see a lot of companies from Western Europe going through that same dynamic, at least as far as considering and comparing China to alternative countries in the region,” Timberlake says. “We’re seeing a lot of U.S. companies and western European companies going through that same decision-making process of whether they should continue expanding in China or look at one of the more established alternatives in the region, like Thailand and Malaysia, Indonesia, Vietnam. India and Mexico are also popping up as possible destinations.”

Perhaps most surprising is that Chinese manufacturers are looking elsewhere too, mainly for the same reasons.

“Interestingly enough we often see that Chinese companies are the ones that are leading the way on this,” Timberlake explains. “They’re also looking for the next great low-cost manufacturing location. We’re seeing some interest by them in countries like Cambodia. They’re looking to continue manufacturing in the region, but they want to do it in the lowest cost location possible.”

And, in many cases, their homeland may not be the default solution it once was.

A Little Less Mojo
A recent LinkedIn poll conducted by Deloitte outlines how China has lost some of its luster in global offshore manufacturing – and what the fallout might be. According to the white paper, about 37 percent of those who participated in the poll between November of last year and January of this year said they expected to shift production from China to other nations by 2014. Meanwhile, 32 percent expected to expand in China to sell products locally, and 10 percent cited plans to grow their use of China as a low-cost platform.

That means, yes, China will continue to attract manufacturing investments – more than a few actually. But the numbers used to be far more favorable. As the study suggests, its future course may veer away from the “factory of the world” toward “factory of China.” Why? There are a number of culprits, Timberlake says.

Simply put, China may not be the cheapest place for foreign companies to do business in anymore. Its greatest advantage – cheap, abundant labor – has been dramatically diluted. Average labor costs have increased significantly over the better part of the last decade.

“Certainly labor costs are front and center in this discussion, and with the double-digit wage inflation that’s occurred in a lot of parts in China, especially in the coastal regions, over the last 10 years, that’s started to take a toll on the cost structure of a lot of manufacturers,” Timberlake says.

Real estate costs, which have increased at “near-manic” rates, are also hurting manufacturers, according to the white paper, citing the recent institution of government-mandated minimum land prices.

Electricity rates are up too, as are corporate monetary rates, from 15 percent to 25 percent, for most foreign companies. And many tax-related incentives are either disappearing or getting progressively more difficult to obtain.

Then there’s the fear of intellectual property protection.

“We’ve run into a lot of companies that are still hesitant to deploy that leading edge technology in China,” Timberlake says. “These concerns have gotten a little bit better over the years, but it certainly still remains among a lot of our clients’ top challenges, especially when they’re thinking about some of their newer or cutting-edge technology.”

China’s greatest competitors are steadily improving, too, offering appealing labor rates that have attracted inbound manufacturing investment that, while not nearing China’s numbers, remains handsomely substantial. These nations’ labor force is increasingly becoming more skillful, and their infrastructure is improving as well.

But attracting – and maintaining – top-tier talent is becoming progressively problematic. Foreign companies and fast-growing local business, according to the white paper, are vying for qualified employees, particularly those who speak English.

“A lot of our U.S. or Western European clients in the manufacturing sector have found it increasingly difficult to not only attract, but more so retain the type of top talent that they need to successfully run an operation in China, whether that’s keeping engineers, skilled technicians, or shop floor mangers. Despite there being a huge talent pool in China, there’s increasing competition all around.”

And if nothing else, there are the various benefits of shortening supply chains, from the small to the large. After all, what executive wants to endure endless strings of all-day flights, or wake up midway through the night for a conference call? That all disappears if you move manufacturing operations out of China and shorten the supply chain.

Besides, shipping products made in China halfway across the world are costly. It’s also time-consuming, and risky. As the world economy seesaws, demand fluctuates. Shortening supply chains quickens response times, reduces exposure to volatile fuel process, and makes running a business so much easier.

This has forced many American manufacturers to shift focus to near shore locations closer to their customers, or even repatriating production to low-cost regions back home. As a result, more U.S.-based manufacturers are either moving production to Mexico – once a dear favorite before the China boom – or keeping them onshore. According to a recent Deloitte poll 39 percent of U.S.-based manufacturing executives and managers said they believed they would deploy its next manufacturing operation in the U.S. In comparison, only 16 percent of respondents cited China.

“Companies simply have more location options than ever before, for various reasons and with various benefits,” Timberlake says.

Looking Ahead
The ground may be shaking beneath the feet of China’s monopoly-like stronghold on international offshore manufacturing, but it’s merely a tremor, Timberlake suggests. The nation will likely remain the champion – or at the very least a major player, – in offshore manufacturing in the foreseeable future.

Companies serving markets in China and other parts of Asia will make certain of that, he says, and China’s strongest neighboring competitors, while greatly improved, still have a long list of uncertainties stapled to their shorter list of advantages. That’s unlikely to change in the near future.

Plus, China’s list of advantages, though shrinking, remains extensive. It still has all those supply networks rooted deep in a still-growing infrastructure, which is backed by business-friendly government policies and investments. And, perhaps most significantly, the talent pool remains bottomless.

“I do not think any of the competing countries individually are big enough to knock China from its pedestal,” Timberlake says, rather straightforwardly. “One thing China continues to have going for itself is its growing consumer demand and its overall consumer spending power.”

He adds, “A lot of clients we have who are facing this same question end up looking at their sales projections in China. Ultimately, China is still too big to ignore, so I do expect that China will continue to attract a lot of foreign direct investment in manufacturing for the foreseeable future.”

But Timberlake is certain that as production costs continue to climb and other unfavorable conditions worsen, fewer and fewer businesses will instantaneously think of China as the go-to option for moving operations overseas.

“As part of this trend we have done some surveying, asking how you expect your Chinese manufacturing to change over the next couple of years,” he explains. “Interestingly enough the No. 1 answer was shifting capacity to other countries, and certainly everything we’ve seen over the last nine months or so continues to re-enforce that. I would say that looking out at least a couple of years we would expect to see increasing interest from manufacturers in the small handful of countries that are most frequently looked upon as alternatives. That again would include Malaysia, Vietnam, Thailand, and a handful of others.”

Timberlake’s prediction is strongly backed by his white paper’s overall projection, which states that the aforementioned competing nations may “catapult themselves into consideration for all types of production expansion or relocation decisions involving the Asia-Pacific region” if they continue along their current growth trajectory in labor, infrastructure, and supply chain capabilities, all of which are needed to support the addition of more foreign manufacturers and investors.

China will not only contend with these quickly-expanding next-door neighbors, but it’ll also be matching wits with faraway competitors too. Think Europe. And, in a comeback worthy of a standing ovation, think North America too. “A movement toward supply chain regionalization is already causing manufacturers based in North America and Europe to reevaluate far-flung supply lines, and in some cases, shift production closer to home,” the report says. Even Africa, if it can quiet the political, social, and infrastructure barricades that continue to dissuade foreign investors, can be a contender, Timberlake suggests.

“When manufacturers started moving operations offshore into China, it was an untested and somewhat unknown region,” Timberlake says. “Now, after sustaining unprecedented growth, they’re looking beyond China and into other territories to tap more of the same.”

Independently, these nearby rival countries pose a minor, almost harmless threat to China’s industrialized supremacy, Timberlake says. Altogether, on the other hand, they will do just enough to make China lose its shimmering role as the default choice for cost-driven, export-oriented offshore production.

Josh Timberlake is a Senior Manager in Deloitte Consulting LLP’s Real Estate & Location Strategy practice. He has more than 15 years of experience in advising Fortune 500 companies on their global facility and location strategy decisions. His specialties include enterprise-wide footprint management, labor market analysis, site/facility inspections, utilities and infrastructure analysis, operating costs/conditions analysis, business risk assessments and real estate/incentives negotiations.

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