Your roadmap to China’s manufacturing market

The global COVID-19 pandemic caused some serious damage in supply

chains all over the world, but nowhere was that felt more than in China.

With four of every five major companies depending on their Chinese

suppliers, the unprecedented disruption caused by the current health

crisis is forcing businesses to evaluate options and be better prepared

against future challenges.

Though many companies may be considering looking for suppliers elsewhere, China will most likely remain an important manufacturing hub. 

China emerged as the central player in global supply chains over the past two decades as Western companies set up major operations in the country to minimize costs and cater to the world's most populated nation.

According to experts, China's role as a major source of manufacturing will not disappear.  There may be some changes in certain industries, but overall, the manufacturing structure will endure.

Before the coronavirus spread around the world and became a global pandemic, the illness affected several provinces in China, mainly Hubei, a key manufacturing region. The unprecedented lockdown that followed forced millions of people to stay at home, causing numerous factories and business to remain closed.

Many international companies had no choice but to stop production because they could not get the necessary parts from China.

Knut Alicke, a supply chain expert at McKinsey, said that during the coronavirus crisis, a lot of companies looked for alternative sources outside of China. Some found them, others could not do it in such a short period of time. Those who found alternative sources will continue to use them in the future, he added.

In the past few years, businesses have been relocating their operations out of China, driven mainly by rising labor costs. The relocations gained momentum during the height of the US-China trade conflict in 2018-19, when companies looking to avoid higher tariffs and rising tensions between the world's largest economies shifted their operations to neighboring countries.

However, experts agree that even as companies set up operations or look for suppliers in other regions, they will continue to maintain a presence in China — a strategy they refer to as China + 1 — to cater to the country's large domestic market.

In a survey made in March by the American Chamber of Commerce in China (AmCham China), 70% of the companies that were questioned said they have no plans yet to relocate production and supply chain operations or sourcing outside of China due to COVID-19.

"In contrast to some global narratives, our China-based data suggests that the majority of our members will not be packing up and leaving China anytime soon," said Alan Beebe, president of AmCham China. "It is worth emphasizing that China appears ahead of the global curve when it comes to restarting the economy following months of lockdown, and many of the reasons why companies are in China in the first place still hold true today."

The Asian nation accounts for 35% of global manufacturing output, McKinsey Global Institute pointed out in a report last summer. The country has also become the largest market in the world for many products such as automobiles, luxury goods and mobile phones, accounting for roughly 30% or more of their consumption worldwide, the report added.

From a business perspective, building resilient supply chains in the wake of the coronavirus also means recognizing that a pandemic could happen anywhere. The decision to move production requires long-term planning and commitment, and is not something that can happen overnight, especially as businesses try to conserve costs as they struggle in an economic downturn.

There are very few countries in the world where a company can find almost everything it needs to manufacture a product. At the same time, the labor force maturity and talent pool in China continues to be a plus.

Supply chain specialists consider that the current outbreak could prompt companies to make their supply chain more resilient by boosting inventories, enlisting alternative suppliers and using data and technology to keep a better tab on even their lowest- tier suppliers and customers.

Though similar concerns were seen after previous disruptive events such as the 2011 Japan tsunami and the meltdown at the Fukushima nuclear plant, the 2002-03 SARS outbreak and the 2008-09 global financial crisis, not many companies decided to adopt those risk-mitigating measures. Most of them prioritized keeping costs down and preferred to stay away from significant investments.

Every time there is a crisis, companies feel the urge to take drastic measures to maintain business continuity functions, and work on supply chain risk management. But once the storm passes, only a few follow through. However, the severity of the current health crisis may finally force companies to execute their plans.

The impact of the COVID-19 pandemic on supply chains has been much more severe than expected. Currently, China has a strong hold on the global supply chains and any disruption affects companies all over the world. In addition, there is growing investor pressure on companies to ensure that their supply chains are stable.

Experts believe that the ability to switch quickly from different production sources in response to future challenges is a key component in building a resilient supply chain. For this reason, a portion of the exporting manufacturing capacity that China had could potentially be shifting out of the country.

Just as some firms are considering relocating their operations, the Chinese government is taking interesting measures to convince them to stay, such as friendlier legislation towards foreign investment and lower taxes.

China’s economy contracted 6.8% in the first three months of the year, with exports plunging 11.4% in yuan terms. The secondary, or manufacturing, sector accounted for 27.6% of jobs in 2018, at more than 214 million, according to official data.

At a recent annual parliamentary meeting, Chinese authorities did not share a growth target for 2020 due to the unpredictability of the health situation. The spokesperson for the congress, Zhang Yesui, said that foreign businesses have not been leaving the country in a major way, and that the United States and China should work together for open supply chains and global growth.

In April, exports unexpectedly rebounded more than 8% in yuan terms as reopened factories rushed to fulfill orders, particularly for medical supplies.

Cross-border financial payments platform Payoneer, which works with e-commerce sellers, saw an “explosion” in business activity in March that has trickled into May, according to James Huang, Payoneer vice president and country manager for Greater China.

Huang expects shifts in consumer behavior will drive more online purchases. He feels cautious in the short-term, but is quite confident about growth for the medium term.

Though China may be the first economy to emerge from economic lockdown, other countries may not be ready to buy in a big way.

Political pressure on businesses’ international operations may grow, and greater scrutiny on China’s role in global markets could accelerate diversification. The rest of the world has become more dependent on China, while the country has become more self-sufficient as it tries to rely more on domestic consumption for growth, according to the McKinsey study.  

Other regions will likely start to grow their manufacturing capacity, as companies seek more diversified supply chains. Ultimately, manufacturing could be more fragmented, with many small factories in different parts of the world, rather than China as “the factory” of the world.

Diversifying the supply chain would require increasing the range of suppliers a factory might choose to order from. Some aspects to consider could be additional costs involved, how quickly they should act, and how sustainable supplies would be.

The new decentralized global supply chain will mean more connectivity among various centers via technology.

The considerations for supply chain management will still center around cost, quality, and delivery. However, additional factors that businesses are considering now include resilience, responsiveness and flexibility.

Even though some manufacturing is moving out of the mainland, China is moving up the value chain through its strong investments in technology, artificial intelligence, robotics and blockchain — in turn developing and producing higher valued goods.

The massive investment pouring into technology could actually move China to a different spot within the supply chain.

At the moment, China faces three dire challenges, some short term some longer.

In the short term, China is dealing with collapsing external demand for products made in the country.  There is also concern of a second wave of viral spread later this year and into next winter, assuming this illness comes back as the flu virus.

The third challenge is supply chain disruption. Japan is paying companies to move out of China and experts suspect that Europe and the United States could take similar measures.

On the coronavirus front, Beijing’s State Council announced recently that nationwide mass testing for the virus will take place to address contagion fears and allow for a wider reopening of the economy. A consumer survey by Morgan Stanley suggests that 94% of China’s workforce is back to work. Restaurant visits and leisure activity trips remain below 40% of normal levels, but the government announced less stringent border controls with the rest of the world.

Should you have questions about your road map to the Chinese manufacturing sector, complete the below inquiry form with your questions and comments. 

DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.


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