What Does The Rise of Manufacturing in ASEAN Mean for Multinationals?

While the rise of Southeast Asia has been discussed widely over the past few years due to its strong consumption demand, the production aspects of the region remain relatively unexplored with many companies not having examined ASEAN’s manufacturing capabilities, its ability to achieve economic integration, and the comparative strengths of the individual members as production units. FSG’s research shows that manufacturing is likely to play a significant role in ASEAN for years to come

The Rise of Manufacturing in ASEAN

Southeast Asia has experienced a strong CAGR of 5.5% in terms of its manufacturing output over the last decade and is now responsible for almost 4% of the global manufacturing output. This growth has been funded both by domestic companies as well as foreign investors; ASEAN surpassed China in terms of the FDI inflow in 2013 and the manufacturing sector received a large chunk of the funds. In fact, more than 30% of all FDI that has flown into ASEAN between 2005 and 2010 (see pie-cart below) has been towards manufacturing, and the sector is likely to continue to be one of the biggest beneficiaries of the growing interest from foreign investors. The major reasons for this drive in investments can be summarized through the ASEAN’s four C’s: Consumption (growth), Cost (low), Commodities (abundant), and Community (single ASEAN trade bloc)

ASEAN 1

However, even though the majority of the ASEAN countries have moved out of the agrarian state and have seen this growth in manufacturing, many are still in the early industrialization phases; meaning that the manufacturing sector is going to continue to see strong growth over the next 10 to 20 years (see graphic on the evolution of countries below) and will play a significant role in the development of the region

ASEAN 2

Assess the Direct Impact of the Rise of Manufacturing

  1. Serving the market: As costs rise elsewhere and the addressable market becomes larger in ASEAN, companies should explore the viability of moving production to the region using a “total factor performance” analysis. It is important to make sure that the analysis looks beyond the simple math of labor-cost and considers total factor performance (labor, transport, leadership, material, components, energy, and capital)
  2. Business customers (B2B) movement: Companies serving other manufacturing and production types of businesses should be assessing what types of industries are likely to invest heavily into Southeast Asia and which are not likely to consider moving beyond China

Gauge the Spillover Effects from the Rise of Manufacturing

  1. Productivity impact: The rise of manufacturing is going to positively impact productivity within the region, which has not seen a large improvement over the past decade. Manufacturing makes outsized contributions to trade, research and development (R&D), and productivity. The sector generates 70% of exports in major manufacturing economies, both advanced and emerging, and up to 90% of business R&D spending. Such productivity growth provides additional benefits, including considerable consumer surplus
  2. Rise in consumption will impact all industries: As the less industrialized countries of Indonesia, Vietnam, the Philippines, Myanmar, and Cambodia move from agrarian societies to manufacturing ones, companies should expect consumption dynamics to evolve. As people move from the less predictable farming sector to the fixed-wage manufacturing sector, they tend to experience strong income growth, increasing their capacity to consume. Even companies not exploring manufacturing opportunities in the region need to be monitoring this trend

Establish a Strategic Role for the ASEAN Region in Your APAC Portfolio

  1. Evaluate a “China Plus” strategy- China’s rise to manufacturing prominence over the past two decades has been staggering. However, rising costs, more sophisticated consumers, and fundamental macroeconomic realities mean that current approaches to manufacturing are losing their relevance. As the imperative for companies in China will be to boost productivity, refine product-development approaches, and tame supply-chain complexity, ASEAN has appeared on the horizon as a viable alternative for companies looking to expand their manufacturing footprint into relatively lower-cost locations. ASEAN countries provide cheaper labor, investor-friendly governments, and are part of established supply chains
  2. Compare the competitiveness of ASEAN (to China and India) – China is unlikely to lose its dominant position as the “factory of the world” anytime soon because of its well-established infrastructure, existing manufacturing facilities, ability to scale quickly, and strong involvement in established global supply chains. However, certain low value-added industries are likely to consider moving out of the country or at least setting up their next facility in Southeast Asia, where the cost of labor can be less than half of that in coastal China. ASEAN countries provide access to several raw materials, and certain locations have strong linkages to trade infrastructure
  3. Explore ASEAN’s complementarity to China- ASEAN countries are also likely to be playing a complementary role to China within several industries that depend on Asia for producing parts and final assembly. Given China’s established role as one of the most productive assembly locations in the world, due to its ability to scale quickly and availability of infrastructure, many companies produce their parts and components in cost-effective locations within the ASEAN region, conduct the final assembly in China, and then have the finished product shipped to the end customer. The ASEAN-China free trade agreement has helped companies create such fragmented supply chains

In FSG’s latest report on the region, titled ‘ASEAN’s Role in Manufacturing’, (a) we explore the rise of ASEAN as a manufacturing hub, (b) diagnose the viability of movement of different types of industries into Southeast Asian countries, (c) conduct a location analysis of the various manufacturing sites in ASEAN, and (d) decipher the impact of the ASEAN Economic Community on manufacturing decisions. FSG clients may click here to see the full report

Is China Losing its Competitive Edge?

This blog entry is the first of a six-part series on China which will cover China’s productivity growth, portfolio management, geographical coverage models, talent management, post-merger integration and sales force effectiveness.

Is China Losing its Competitive Edge?

Many multinational companies are re-assessing China’s competitive advantage as a manufacturing base since labor arbitrage is becoming less compelling. Although China’s productivity gains (as measured by TFP growth) outpaced other major economies in the first decade of the 2000s, this rapid growth was interrupted by the financial crisis in 2008 and has been slowing ever since.  This is largely due to overcapacity and a “crowding out effect” caused by the massive fiscal package that Beijing put in place to offset the effects of the global financial crisis.

"Made in China" Industry Competitiveness Matrix

 

We believe that China is gaining momentum in higher value-added industries such as heavy machinery, information technology, and medical devices, but losing competitiveness in low value-added manufacturing to other low-cost Asian countries, even when it comes to serving the domestic market. In a workshop that I have run recently, we discussed the possibility that “Made in Bangladesh” apparel will begin to flood the Chinese market in a few years.

As China continues climbing up the value chain, more and more of its companies are expanding abroad to other emerging markets. This leads to interesting dynamics on talent requirements, intellectual property, and portfolio management.

 

 

What you can learn from Apple in China

Apple Factory

The following is an excerpt from a recent entry in the Silicon Hutong blog by Frontier Strategy Group expert adviser David Wolf.

You could argue that this story [Apple in China] and the reception it is getting is a function, in part, of the end of the Steve Jobs Reality Distortion Field, or, as I overheard someone say the other day in reference to Apple, “the King is Dead, the Gloves are Off.” That may be true, in part, but I think that this story is the harbinger of a wider issue plaguing the global manufacturing sector, and the challenges Apple is facing with its suppliers are simply the most visible examples.

The problem goes deeper than the conflict implicit in asking a supplier to give you the best price AND to manage its business in a way that increases its costs. The matter of working conditions is part of a bigger question about the value and importance of control over the means of production. (Don’t worry, I’m not about to go off on a Marxist tangent here. Bear with me.)

I started my career managing the output of 30-odd factories and suppliers in greater China making furniture, jewelry boxes, and small gift items for a medium-sized US importer. I learned a hell of a lot from that job, but the lesson that has stuck with me throughout my career is that you cannot change what you cannot control. We like to think that a customer like Apple would, by virtue of the size of its business, be able to strong arm its suppliers into complying with its codes of behavior, or even “incentivize” a supplier to go along by raising prices. In reality, it is nowhere near that easy. Any customer, even one the size of Apple, exerts influence over how a supplier is run, but not control. A customer can exact some concessions from a supplier on factors outside of product features and quality, but at some point, any self-respecting factory owner is going to push back and say “you may buy from me, you may be my biggest customer, but you don’t own me. I’ll give in to you on some things, but beyond that, you need to let me run my own business.”

The original post is called, “The Beginning of the End of Outsourcing

 

Industrials Companies are Affected by Lower Capital Goods Investment in China

China industrials

Industrial companies are feeling the slowdown of investment acutely. Siemens has reported a 16% YoY decline in revenue from China in Q1 FY 2012

Other industrial giants such as Caterpillar and ABB have also experienced minor declines in sales in the most recent quarter, the first such decline for many companies since they entered China

Companies tied to the real estate market and infrastructure investment have been hit particularly hard. Elevator maker Otis has seen its YoY revenue growth rate slow to 7% in Q4 2011 against an average of  20% throughout the year

Frontier Strategy Group View

China is making small steps to loosen monetary policy, but the actual extent of loosening is going to be smaller and slower than many international investors expect

As a result, industrial companies are going to experience moderate to negative growth, depending on how dependent they are on infrastructure investment, real estate, and heavy industrial production

The super high growth rates of 2009 and 2010 are not likely to be seen again anytime soon
as demand falls back to a more sustainable growth rate

 

Higher-value Manufacturing is New Mexican Growth Engine

Multinationals can count on increased consumer spending as the evolution of the Mexican economy toward higher value manufacturing supports a more resilient and prosperous Mexican middle class. Companies servicing the automobile and heavy machinery sectors are set to benefit the most from the continued diversification of the Mexican economy.

Where is China manufacturing transitioning?

The three most critical considerations when deciding to relocate manufacturing are:

  • Total manufacturing cost (as opposed to labor cost)
  • Markets to serve: Domestic vs. Exports to developed markets
  • Capital intensity: Labor intensive vs. Capital intensive

Transferring Production Across Emerging Markets

(Source: Foxconn Website)

Foxconn is one of the most well-known emerging-markets based manufacturers. With labor prices increasing along with a string of suicides in it’s Chinese factories – the Taiwanese firm is looking to Latin America for new production capacity. The following is a cross-post from the China and Latin America blog which details Foxconn’s recent push into Brazil.

On August 6th, the Financial Times featured an article on Taiwan electronics firm, Foxconn (富士康科技集團), and its founder, Terry Gou. Foxconn controls close to half of the world’s outsourced technology products, including a number of Apple favorites (iPads, iPhones, etc).

According to the article, Mr. Gou recently announced a plan to place one million robots on Foxconn’s production lines. Automated production, he believes, will generate growth – the company made $80 billion in revenue last year, but is finding it hard to expand its market share.

Before Terry Gou ever announced his fondness for robo-employees, Foxconn was already seeking greater efficiency and market access through global expansion. In addition to production facilities in “greater China” (where it employs nearly one million people), Foxconn also operates in Europe, Australia, the United States, and Latin America. The company’s relatively new Latin American ventures (currently limited to Brazil and Mexico) provide greater access to local markets and close proximity to North American consumers.

Foxconn is now contemplating an additional investment of $12 billion in Brazil, which was first announced by President Dilma Rousseff during her visit to mainland China in April of this year. The company already operates at a limited capacity in the South American country, but the proposed investment would significantly expand production capabilities. New investments would offer Foxconn direct access to Brazil’s market and a means of avoiding the country’s notoriously high tariffs.

If the deal goes through, it would be Foxconn’s largest global investment. But the company’s leadership has hesitated in recent months.  Mr. Gou expressed concern about a culture in which “there’s all that dancing” and “as soon as they hear ‘soccer,’ they stop working.” Foxconn has asked the Brazilian government for certain labor and infrastructure guarantees and may eventually reduce the amount it is willing to invest.

Foxconn’s Mexico production is based near Ciudad Juarez. Its massive facility employs approximately 8,000 workers from nearby towns. The company’s presence was warmly welcomed by politicians in both Chihuahua and New Mexico, but faced controversy after a disgruntled worker set fire to the facility’s activities center.

Further expansion into Latin America – though certainly welcome – isn’t guaranteed. Foxconn’s founder seems to prefer Chinese manufacturing, even despite rising labor costs and the recent Shenzhen tragedy. Chinese laborers are thought to be very skilled, to tolerate more, and to work longer hours than many of their foreign counterparts. Mr. Gou believes that rising labor costs can be offset by a move to China’s cheaper inland provinces.

China’s remarkable distribution network is yet another advantage – shipments from China to the US are generally cheaper even than shipments from Brazil.

But as Foxconn and other firms look to expand market share, Latin America’s emerging markets are bound to receive more attention. Although fresh foreign investment in the country’s stock market has slowed (especially in the investor exodus this week), foreign direct investment in Brazil has increased steadily over the past year. As one of the fastest growing BRICS countries, its consumer market is attractive to investors. The country’s Mercosur affiliation also allows for tax-free export of certain goods to other member countries.

Mexico, for its part, boasts proximity to the US and a skilled labor force. Its manufacturing sector grew thirty percent in the first three months of this year and its share of US imports is also on the rise.

As for Mr. Gou’s cultural bias: if he ultimately decides to replace many of Foxconn’s workers with robots, futebol (fútbol) fanaticism and a proclivity for dancing should no longer be of tremendous concern.

The original post is titled: “Mr. Gou Goes to Latin America” and can be found here

China Remains Competitive in Manufacturing Despite Rising Labor Costs

Due to rising labor costs in China’s coastal areas, many companies are re-evaluating their manufacturing strategy. Often they face a choice between other low-cost Asian countries and inland China. These manufacturing choices are likely to differ from industry to industry. Companies sensitive to labor cost will move out of China, while companies requiring total manufacturing solutions will move to inland China.

Trends:

  • Wage growth in China has outpaced most major emerging economies in the last 5 years, resulting in China’s labor costs being among the most expensive in the developing world
  • Some consumer goods companies traditionally using China as a manufacturing base have started to seek alternatives
  • Vietnam overtook China to become Nike’s largest manufacturing base in 2010, contributing 37% of Nike’s global output vs. 36% by China
  • However, many high-tech companies are increasing investment in China, particularly in the west
  • Global PC makers HP, Acer and Asus have invested hundreds of millions of dollars in western Chinese cities Chongqing and Chengdu, a fast growing laptop manufacturing hub which will produce 1/3 of global output in 2011

Drivers:

  • Companies moving out of China tend to be in labor-intensive industries in which labor is a large component of cost
  • China still has advantages in labor productivity, proximity to a large domestic market, and support from industry clusters, which are important for high value-added industries such as technology