Asia’s exports are dominated by electronics and as production costs rise in one country, supply chains shift to another. Is there more to it than that? Finbarr Bermingham reports.
This article is brought to you by Asian electronics supply chains. The MacBook on which these words were typed was made in China. Half of the interviews contained within were recorded on an Olympus dictaphone, designed in Japan and made in China. The other half were recorded on a Xiaomi phone – you guessed it – made in China. Look around any office or home, and you will find yourself surrounded by electronic devices made in East Asia.
Within each of those gadgets, there will be a universe of other widgets, each with a supply chain of their own. And while China remains the absolute king of final product assembly, more and more, the parts and components that go towards finished electronic goods are being made elsewhere in Asia.
Look at the statistics at the front and back of this publication. Electrical goods and electronics are by far the region’s biggest exports. The second highest? Electrical and mechanical components: the nuts and bolts that form export number one. While the finished goods are often exported to western consumer markets, many of the components traverse complex intra-Asian supply chains, through Vietnam, Thailand, the Philippines and Malaysia, before eventually ending up at an assembly plant in China. For each of those four countries, electronics are the largest exports, by some distance.
For manufacturers in Asia, this complexity is challenging. A study by consultancy Bain & Company found that for 70% of executives in Asia Pacific, supply chain management is a top management priority. Only half believe that their organisation is ready to address the issues at hand, primarily rising costs.
The evolution of cost is crucial to this story: rising costs in China is leading to supply chains being pushed out to other parts of emerging Asia. A recent study by Euromonitor, a market intelligence firm, showed that wages in China are now close to the hourly rate in some eurozone countries, such as Greece and Portugal. This is despite the fact that GDP per capita in China is still less than half the level of those countries. In the decade to 2016, hourly manufacturing wages trebled to US$3.60, more expensive than anywhere in Latin America and higher than the average wage in the rest of China’s labour market (US$3.30).
“China’s main benefit in the past has been a cheap source of labour. Some companies might deny that, but that’s the principal if you look at the bottom line,” says Richard Smith, Asia director at supply chain consultancy Crimson & Co.
A specialist in SAP implementation, Smith explains that he is currently working with a company implementing a global instance of the software into its Asian operations. Staff trained in China to use SAP were subsequently poached by other manufacturers in the country, often at a doubling or tripling of salaries.
“When looking for a manufacturing planner, you’re looking for someone with 12 to 15 years’ supply chain experience. It’s been tough in the past to find enough of those in China. But it now has those people, and the salary demands are increasingly expensive,” he adds.
The rise of the regions
Rising labour costs are a large part of the reason for companies setting up manufacturing facilities in Southeast Asia, and Vietnam is one of the most attractive destinations. The CEO of Intel Products Vietnam claims that the company manufactures 80% of the world’s microchips across a number of Vietnamese sites, while Samsung makes most of its smartphones in Vietnam too. In total, Samsung exports US$50bn in electronic goods from Vietnam each year, compared with the country’s total exports of US$170bn.
IHS Markit research shows that the average factory worker in Vietnam earns US$2.33 per hour, which is a 36% cost saving on labour alone, compared to China. Add to this a well-educated workforce and the attraction of the labour market there is clear.
Jong Woo Kang, principal economist at the Asian Development Bank (ADB), tells GTR that in the years to come, “Vietnam could be a leader in electronic manufacturing”.
“Apart from the low wages, Vietnam also offers good conditions for infrastructure. Trucking times to port are quite short, so they can easily ship products to other countries. That’s a big incentive for multinationals to outsource manufacturing to Vietnam, the infrastructure environment for their subsidiaries,” he says.
Vietnam has some of the best trade infrastructure in emerging Asia. In fact, they built so many ports and roads that there’s not enough trade to make them work. You’re left with a country that has port infrastructure 10 years ahead of its time, which is not paying for itself: bad news for the international investors who piled into the project financings, great news for manufacturers, whose supply chains are now cheaper as the price of transportation has been driven down due to overcapacity.
Malaysia is another country with better than average infrastructure (relative in regional terms) and which also has a highly-educated workforce. Its proximity to Singapore – one of Asia’s financial and corporate centres – has helped southern Malaysia become a manufacturing hub in itself, while the Penang area in the country’s north is also an industrial heartland.
Governments in the region (as they do throughout the world) are also providing financial incentives to companies considering setting up in their jurisdictions, often in the form of tax breaks or cheap land. This is the case in both Malaysia and Vietnam, as well as Thailand, the Philippines, and even Indonesia, which has a more fledgling electronics sector.
David Gonsalvez is the CEO of the Malaysia Institute for Supply Chain Innovation (MISI), a joint venture between the Malaysian government and the Massachusetts Institute of Technology (MIT). In a career working on supply chains around the world, it’s a tactic he’s seen everywhere.
“In Zaragoza, Spain, the government created a logistics centre [called Plaza], which is a huge distribution centre. They provided land, facilities, infrastructure and tax incentives for companies to locate there. That created a huge logistics cluster in 2003, now there are 250-plus companies there. It wasn’t organic, nor came out of expertise in Zaragoza or something in the soil. The government created it,” he says, noting that the trend is occurring throughout Asia’s burgeoning electronics hubs.
In Vietnam, similar incentives exist. If manufacturers set up in special economic zones, often located in troubled socio-economic areas, they can expect to pay a lower rate of income tax. The more you manufacture, and the better the quality of the goods, the better the tax break. For example, if you spend D6tn (around US$260mn) on a manufacturing project you will enjoy a tax holiday over a three-year period. If you continue to grow the headcount and manufacture “internationally competitive goods” (for example if the goods produced meet EU import standards), this can be extended to a 15-year period.
The Thai tax code generally prohibits foreigners from owning land within the country. However, if a manufacturer wishes to set up in a special industrial zone, the company may be permitted to buy land there, at a good rate. Their chances are improved again if they can prove that some of the raw materials for manufacture are sourced within Thailand – adding to the incentive to have a locally-based supply chain.
This “clustering” helps to explain the success of some of Southeast Asia’s emerging manufacturers. When they went into Vietnam, Samsung created a huge network of more than 200 local suppliers, because they were needed. These backward linkages spawn industries, and over time, countries in Asia are becoming regional champions in certain electronics exports, often thanks to these multinational first-movers.
After China, Thailand has become the world’s second-largest exporter of hard disk drives (although the growth in cloud technology may soon render some of these obsolete). The Philippines has long been a hotbed of application and software design, as well as testing. You’ve read about the booming industries of mobile technology and microchips in Vietnam.
Generally speaking, the more parts of your supply chain you can have in one country, the better. Across Southeast Asia, export and import regulations are changeable and complicated. Importing parts can be expensive and can take time.
Smith at Crimson & Co is currently working with a client that has plants in Thailand, Singapore, China, South Korea, Japan and Taiwan, bringing partially finished goods from Europe and the US to be finished in local plants for local markets.
He says: “From a transportation point of view, sometimes it’s cheaper to finish the product in Korea, ship it into Nanchang [in China] and pay the import duty on that. It’s sometimes cheaper to have the longer supply chain and lower transportation costs than finishing it in China, but it’s a case-by-case thing, depending on cost of materials, base manufacturing cost, transportation cost, etc. You have to work that out for every material.”
Smith adds: “Because the rules change on a regular basis, trying to maintain a pan-regional strategy from a material basis, what you manufacture where, might be the right decision this year, but could be quite different next year.”
As well as helping navigate the complexities of Asian regulations, clustered supply chains can help raise the standard of production and the workforce, as well as the quality of manufacturing and ultimately, people’s lives. This in part explains China’s progress: so many companies set up in China and trained local people. These highly-skilled workers became too expensive, so now China is focusing on higher-level engineering, shifting less technical work overseas.
In electronics, clustered supply chains are also better positioned to deal with the ever-changing consumer demand. Apple upgrades its phones incessantly, while a television made two years ago already seems outdated to some. The underlying tech, however, shares much of the same components.
“It would be easier if they were clustered, especially with electronics and short lifecycles. Supply chains are used to product changeovers every six months. Moving from desktop to laptop to tablet is not as disruptive as an industry with a long product lifecycle, say like automotive, which is five, six years, where you have an established supply chains. Moving to electric vehicles, would require a significant shift in supply chains, for instance,” says Gonsalvez at the MISI.
In moving from desktop computing to laptop, and then again to mobile, however, you’re still using memory and display components. The tendency for suppliers to be able to change over rapidly exists, inherently. If you are clustered, it’s easier to find that capability within the local network, than going elsewhere.
It also makes it easier to finance the supply chain. Sean Corrigan, who heads Wells Fargo’s trade programmes and solutions team for Asia Pacific, tells GTR that providing a supply chain finance programme to a client is more difficult if that supply chain straddles multiple countries in the region.
“We don’t necessarily lend directly to the SMEs locally unless there’s a buyer support programme. It does create challenges as they enter new markets and deal with SMEs that aren’t necessarily supported. Letters of credit are still part of the story, but it’s more and more open account, so it leaves those suppliers on their own in a lot of cases,” he says.
The challenges of the future
Given the emphasis many companies place on cost, you could be forgiven for thinking that the shift in supply chain locations is a race to the bottom: multinational companies continuing to plunder frontier markets for cheaper production and higher margins.
This may be the case in lower-skilled manufacturing such as textiles, which has led to production shifts to the likes of Cambodia, Pakistan and, most notably, Bangladesh, but for electronics there is a limit. Quality cannot be sacrificed for cost-savings, which is why many companies have thought twice about manufacturing in Asia – where despite all the potential, it is still difficult to find highly-skilled workers – and re-shored to the US or Western Europe, or near-shored to the likes of Mexico or Romania.
In this sector, when human capital becomes too expensive, and newer, skilled markets have been exhausted, the end game will be robotics and automation.
“I sit in Japan and see it here,” says Corrigan at Wells Fargo. “Japan has a small workforce, but is keen to keep high-level manufacturing intact. How do you do that? You make investments in automation. Then you move more fundamental pieces of manufacturing to emerging countries, such as China or Vietnam. It benefits those countries, helps them start moving up the value chain. But nothing remains static, innovation is occurring. Everybody wants to continue to move up because that’s where you make the money.”
For now though, East and Southeast Asia is absolutely dominant in electronics and its supply chains will remain complex. Even as regional integration continues to improve through the multitude of regional councils, including the Asean group of nations and the Asia Pacific Economic Co-operation (Apec) forum, and free trade agreements, such as the Trans-Pacific Partnership (TPP) and the Regional Comprehensive Economic Partnership (RCEP), the challenges will persist.