Subcontract Manufacturing In China: The Risks And Alternative Options

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By: Doug Donahue

June 18, 2021

Reprinted with permission from Forbes.com

Companies are leaving China in droves. A Gartner survey of supply chain leaders showed that 33% have plans to move at least a portion of their manufacturing out of China by 2023. The list of companies rethinking their subcontracting strategy includes everyone from Apple and Dell to the toymaker Hasbro. Outsourcing manufacturing to China, once the panacea for companies looking to scale manufacturing quickly and affordably, appears much less attractive than before. The question is why?

New Risks In Subcontracting To China

The exodus from China illustrates a trend that has been developing for at least the past five years. China was once the world’s preferred subcontractor, but that advantage has slowly eroded as other countries in Asia and elsewhere have developed competitive manufacturing capabilities. Issues with intellectual property theft have further caused companies to rethink their relationship with China.

But recently, as the founder of a company that helps companies transition from offshore subcontract manufacturing, I've observed that a more problematic trend has emerged, at least from America’s perspective. Chinese companies appear increasingly willing to prioritize customers from countries Beijing sees as stable, predictable business partners, moving American companies to the back of the queue. The trading relationship with the U.S. has moved from cooperative to combative, as many Chinese companies have declined or delayed orders from American customers. From a businessman’s perspective, their rationale makes sense. As Paul Ericksen and Eamon McKinney pointed out in a recent IndustryWeek editorial, “the Chinese public have been questioning why they are helping to support American manufacturing, when America seems intent on destroying China’s.”

Tariffs resulting from an ongoing trade war don’t help the situation either. American companies that subcontracted manufacturing to China as a cost-control measure have seen those savings vanish due to rising landed costs. Without a clear end to the trade war in sight, companies that import goods or subcomponents from China must contend with added costs and continuing volatility that make profitability elusive or impossible.

Even if the tariffs are removed, I believe American companies will remain at the end of the order chain for some time. What business owner wouldn’t prioritize the needs of their more frictionless customers? If you ran a Chinese company that could do business with customers all over the world, would you pick a trading partner whose main attribute is uncertainty?

The outbreak of the pandemic only made matters worse. An event of that speed and scale put the global supply chain through an unprecedented test of strength. And it failed that test in many instances, evidenced by empty shelves and production delays, revealing the supply chain to be far less resilient, agile and adaptable than it was credited for. As companies continue to face supply chain issues and search for ways to prevent the next catastrophe, many are rethinking how they manufacture. Strategies that worked in the pre-pandemic world may not work anymore.

Midsized Companies: The Hardest Hit

In my opinion, some companies (the majority) will elect to stay in China because their ownership teams believe the rewards outweigh the risks. Others, however, will decide to leave and discover that the exit strategy isn’t always obvious.

The biggest companies have the resources to move subcontracting out of China or supplement it with domestic or nearshore production. Equipped with the means to scour the world for alternatives and budgets to spend on relocation, such companies can do whatever it takes to establish manufacturing wherever it’s most advantageous.

Small and midsized companies don’t have this same advantage, however. In many cases, they subcontracted manufacturing to China in the first place because it streamlined the path to production, required less startup capital and offered scalability. For companies without extensive manufacturing expertise or the budget to build facilities, subcontracting to a country that offered a robust manufacturing infrastructure available on demand looked like the best (often only) way to get a product off the drawing board and into the market. Abandoning this arrangement won’t be easy.

Emerging Alternatives To China

Choosing where to outsource manufacturing isn’t obvious anymore, which is positive and negative. Companies must put more thought into where and how to manufacture now that China is no longer the clear-cut option. However, there are more viable alternatives than ever — some with unique advantages.

Countries like Vietnam, India, and Romania have all matured their manufacturing sectors to the point where they rival China in many ways. Midsized companies looking for affordable yet skilled labor, advanced manufacturing facilities, and favorable regulatory conditions can find those on every continent. Having more countries to subcontract with encourages those countries to compete for business. Furthermore, it allows for an agile, geographically diverse manufacturing strategy that can pivot to multiple places as circumstances demand.

Depending on the product and operating process, the most competitive countries to manufacture in might be the U.S. or Mexico. Recent history has proved the value of having a smaller, more condensed supply chain rather than one that snakes around the world. Manufacturing and operating out of the same facility or even the same country can make for a more cohesive operation. Consumers also prefer products labeled “Made in America” and will pay a 20% premium in some cases. Reshoring or nearshoring isn’t the right option for every company (and the same goes for leaving China). That being said, reshoring or nearshoring can help some companies unleash new opportunities propelled by domestic production.

I encourage every midsize company outsourcing manufacturing to China to evaluate whether the situation is sustainable and what the alternatives have to offer.

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