Apple’s recent reported difficulties establishing a supply chain in India show just how hard it is for companies to reduce their dependence on China at a time when the COVID-19 contagion and the U.S.-China trade war have made supplier diversification an important strategic question.
Much has been written about the challenges facing Apple, for whom China is both an important market, and a critical supply base. Two of Apple’s Taiwan-based suppliers, Foxconn (Hon Hai Precision Industries Company) and Pegatron have pushed into India, and Pegatron's chairman, Tung Tzu-hsien, recently told the Nikkei Asian Review that China lost its competitiveness more than five years ago.
Yet China remains core to Apple’s production, as it is to many electronics manufacturers. What makes China so attractive for the electronics industry, and what are the important considerations if a company is going to relocate manufacturing to India, Viet Nam, Indonesia, or some other low-cost region?
Large, low cost, flexible labor force
What made China so attractive in the 1990s and early 2000s was a seemingly limitless supply of low-cost semiskilled labor. In the late 1990s factory direct labor often cost (fully burdened including social welfare benefits) less than 50 cents per hour, and this was for a workforce that didn’t mind (and in fact liked) working overtime including on Saturdays and Sundays. The cost to shed that labor was minimal as well, so if you were an Apple supplier and needed to do a ramp-up to support a new product launch, it was possible to hire 100,000, or 250,000 workers and get them to work 60+ hours a week on multiple shifts. You recruited them from inland provinces and housed them on campus in dormitories, so you could draw on a vast pool of hands in relatively short order. Generally speaking the workers were quite good; they were disciplined and good at following instructions. The big Taiwanese contract manufacturers – Foxconn, Quanta Computer, Wistron, Pegatron, Compal, Inventec – pioneered this way of working, and got very good at it.
Employees line up for roll call at a Pegatron Corp. factory in Shanghai, China. Photographer: Qilai Shen
Companies like Samsung have replicated this model in Viet Nam on a smaller scale, but as many companies rush there, labor rates are getting pushed up. As firms look for alternatives to diversify their risk, Indonesia and India jump out because of their large and relatively young populations. But where do I find the workers, and is there infrastructure in place for moving them to my site, housing them, and putting them to work? The Taiwanese, when they pioneered this model in China three decades ago, relied on common language and cultural intelligence developed over many generations. Many firms are now developing sites in India, but it will take time.
When companies first moved into China, many electronics assemblers were supported by logistics specialists who imported components from across East Asia and around the world, and assembled them into “kits” that they shipped into factories in special economic zones for assembly. For example, a factory might assemble a kit into a TV set or a game console, and ship it back out. Hong Kong played a central role then as a logistics hub. In the Chinese government’s great wisdom, they offered companies incentives to localize their supply chains. This meant free land and tax incentives to get your suppliers to set up within your own or nearby logistics parks. As more and more of the supplier base shifted from Japan, Taiwan, Korea, the U.S. and elsewhere to local sites, the factories enjoyed more efficient delivery of raw materials and components, several times a day if necessary. This model was actually invented by Japanese firms like Toyota, but the Chinese scaled it across multiple sectors.
If you move to a new region, you are faced with reestablishing such a supplier infrastructure. While it’s possible to import components, that generally means delays and risk of things going wrong that might stop your production. If you read between the lines on what Pegatron is doing by moving non-Apple production first, it is probably so they can use it as a way to develop the infrastructure before they put turn loose their most demanding customer on the poor factories.
If you are manufacturing for export, the infrastructure to support efficient logistics is vital. In the days before containerized intermodal shipping became the dominant way of moving products around the world, proximity to seaports was a huge advantage. That was why there was so much manufacturing on the docks and streets around New York harbor. Efficient container shipping changed all of that of course, as factories moved inland to New Jersey and Pennsylvania. When China opened up in the 1990s, Hong Kong’s early investments in port infrastructure became a huge asset. From 1990-95, Guangdong Province’s share of China’s total exports grew from 18% to 46%, and 90% of this volume was exported via containers through Hong Kong, making it a hub for managing supply chain and logistics. In the Pearl River Delta today, four ports (Yantian, Shekou/Chiwan, Nansha, and Hong Kong) handle tens of thousands of containers a day using a modern and efficient infrastructure of roads, bridges, and tunnels that serve a vast network of factories in the hinterland.
Yantian International Container Terminals, operated by CK Hutchison Holdings Ltd.'s Hutchison Port Holdings Trust (HPH Trust). Photographer: Qilai Shen
That is probably why companies going into Indonesia like Batam Island, which is right across the Singapore Strait from one of the world’s largest and most efficient ports. It is also one of the attractions of Chennai, India – it is relatively accessible. I visited a large pharmaceutical manufacturer south of Hyderabad a few years ago, and the plant manager bemoaned the difficulty of getting trucks over the roads to a port (he usually used Chennai). On top of that, Indian ports are relatively inefficient, so many of the big liner companies prefer to drop off containers destined for India in neighboring Colombo, Sri Lanka, which has a very efficient port, for transshipment to India.
As important as the physical infrastructure is the “soft infrastructure.” When goods cross international borders, countries often require inspections, collect tariffs, or impose various specific rules and regulations. All of this translates into delays and added costs. Acquiring land for a factory, the permitting process, and many other issues contribute to making a country easy or difficult to do business in. Compared to China, where provinces and cities compete with each other to attract new factories, countries like India still have quite a way to go.
Can Apple’s suppliers diversify away from China?
The answer of course is yes, the question is how long will it take and how much will it cost? The U.S. China trade war, and the COVID-19 contagion were risks whose cost was not priced in to the overall cost of manufacturing in China. Over the next few months as we see more of those costs become explicit, my prediction is that companies will increasingly be willing to bear the costs of moving into new countries. It will just take time.
Source: Forbes, 06/03/2020