Why companies are diversifying in China and Southeast Asia

21 August 2019

Amid rising labor costs and tariffs, manufacturers are increasingly looking to diversify their operations beyond China. While some have moved shop to Vietnam, Thailand, Cambodia, Malaysia or Indonesia, others are keeping their China plants but eyeing other South Asian countries as possible alternatives or expansion sites.

The ongoing trade wars are accelerating a longstanding trend. Global manufacturers have been shifting production to Southeast Asia for several years as labor costs in China have risen. In the five years from 2013 to 2017, wages in China rose 44 percent, compared to 30 percent in Vietnam, 28 percent in Malaysia and 11 percent in Mexico, according to International Labor Organization data as reported by the Nikkei Asian Review. New environmental regulations in China have also raised the cost of doing business there.

Trade war volatility

Companies gained further incentives to diversify after the U.S. imposed 25 percent tariffs on $250 billion in imports from China last year. While those tariffs remain in effect, the political situation is volatile, making it hard for businesses to know what to expect.

In August, in addition to the existing tariffs, the U.S. threatened to impose new ones of 10 percent on $300 billion of products, including many consumer goods, which were largely unaffected by the first round. With the two tariffs combined, nearly every product exported from China would be affected.

The new tariffs were scheduled to go into effect September 1, but on August 13, the U.S. changed course, delaying tariff implementation for many products, including smartphones, laptop computers and toys, until December 15 — ostensibly to prevent harm to the U.S. Christmas shopping season.

Perhaps most surprisingly, the U.S. Trade Representative (USTR) also announced that tariffs for some goods, including bibles, child safety seats, construction cranes, and shipping containers would be exempted entirely, “based on health, safety, national-security and other factors.” In addition, the agency is developing a process that would allow companies to appeal tariffs if they show their business would be significantly harmed.

Trade representatives in the U.S. and China said they will hold further phone conversations in two weeks, and Trump said they would meet in again in September.

Diversification strategies

Uncertainties about tariffs make it difficult for manufacturers to create plans for their China factories, and they have taken a variety of approaches to solving the problem.

Eighty percent of U.S. companies and 67 percent of those in Europe have begun sourcing products in other countries or plan to do so in the near future, according to quality-control vendor QIMA. A poll by the American Chamber of Commerce found that 41 percent of American companies are considering moving their Chinese factories. 

Some companies just starting foreign outsourcing have bypassed China to select lower cost nations. Britain’s Dyson, for example, moved its manufacturing from England to Malaysia, where costs are 30 percent lower.

Apple, Dell, Google and Amazon, have all discussed shifting product lines to Southeast Asia, and some have moved portions of their operations. Apparel and shoe manufacturers made the move years ago, heavily concentrating operations in Vietnam, where exports to the U.S. increased 38 percent in the first four months of 2019.

But it may be a Pyrrhic victory. In a recent television interview, President Trump said “… a lot of companies are moving to Vietnam, but Vietnam takes advantage of us even worse than China.” He called Vietnam “almost the single worst abuser of everybody,” leading to speculation that tariffs may soon be imposed there as well.

Manufacturers within Asia, including some in China itself, are also diversifying. Some are opening plants in Malaysia. Taiwanese iPhone assembler Pegatron recently spent $300 million to open a new factory in Indonesia. Others have joined the exodus to Vietnam, Thailand and Cambodia.

But manufacturing and land costs in Southeast Asia are rising quickly as foreign companies move in. Production demands are overwhelming some factories, and product quality is deteriorating, according to QIMA.

Some companies may give several countries a try in search of the right balance between cost and quality. Electronics manufacturers Sharp and LG, for example recently shifted factories from Thailand and Vietnam to Indonesia.

For most companies, the strategy is to diversify rather than pull out of China entirely. China offers the skills, experience and capacity that manufacturers know they can depend on. And in response to the tariffs, China has recently cut back on foreign investment restrictions.

Trade war pains

While manufacturing diversification is likely to continue, recent developments provide hope that the trade wars will reach at least a partial truce. In China, where leaders are encouraging the development of more sophisticated manufacturing, there is less concern than many suppose about shifting low-cost production to other countries. Nevertheless, both countries are aware that escalating trade wars will hurt their economies, and are highly motivated to arrive at a solution.