China +1 Strategies of German Companies in Vietnam
Updated: Feb 16, 2020
There is currently a lot of movement of enterprises from Germany re-orienting from China to Vietnam. They are complementing their existing Chinese operations with new activities in Vietnam regarding sourcing and investments. Within this blog post we will assess what “China +1” strategies are as well as why and how they are being applied to Vietnam by German companies.
What is “China +1”?
The term China +1, or “China plus one” is still rather new. On the one hand, it has arisen from China’s recent economic success and on the other hand it has to do with an increasing attractiveness of other Asian countries that also evolved in the meantime. German companies went “all in” with their China operations during the past 30 years. They invested heavily into manufacturing activities that not only served their existing worldwide markets but also a growing Chinese clientele. They have been lured in by a promising new market and low labor costs. Expenditures for employees also have been a major driver for sourcing: The country has become the most important origin for a slew of items that are consumed not only in Germany but worldwide. In fact, many German companies concentrate nearly 100% of their Asian investment holdings and sourcing operations in the “Middle Kingdom”. This is naturally exposing them to risk emanating from adverse internal and external developments in China.
There are currently three major trends that drive German companies to re-assess their activities in China:
Rising labor costs (have tripled over the past decade)
Changing investment environment (e.g. perceived “un-welcomeness” of foreign investors)
Sudden shocks (e.g. 2018: Implementation of environmental rules, 2019: US-CN trade dispute, 2020: Corona Virus)
To mitigate these challenges and the risk arising from new developments, German companies are looking for alternatives for manufacturing investments and sourcing operations. They often find them in South East Asia with Vietnam being a prime destination. It is important to note that these “alternatives” for investment and sourcing are an “addition” to existing Chinese operations. They are not “shifting” from China to Vietnam. If a process in China should be replaced by activities further down south it typically uses the Vietnamese comparative advantages, e.g. lower labor costs. Back in China, these companies then employ the benefits the country has to offer, such as a highly qualified workforce or proximity to target markets.
Activities in China will therefore be complemented by operations in a new market. Hence: “China +1”. Naturally, some companies also extend their manufacturing or supplying networks to even more new destinations. In these cases the term “China +X” may also be applied.
China +1 and Sourcing in Vietnam
For most German companies coming to Vietnam, “China +1” plays out in the realm of sourcing. From our experience, there are three industries of upmost interest in this context: 1) metal processing, 2) furniture and 3) electronics. Generally, we are seeing a lot of potential four sourcing operations in Vietnam. However, there some industry specific challenges with pricing as well as supplier and product availability which we have explored before in our blog: https://www.deinternationalvietnam.com/post/vietnam-export-industries-and-sourcing-potentials
We are typically approached with sourcing requests in China +1 context for the following reasons:
Rising costs: Most of our customers do not know the exact composition of their Chinese suppliers’ calculation. Nevertheless, they suspect that increasing payrolls are to blame for escalating product prices. These companies then try to reach a more competitive solution with Vietnamese suppliers. They assume that their lower personnel costs should result in lower price tags. It should be noted though that in our experience this goal can sometimes not be reached.
Sudden Shocks: For us in Vietnam, inquiries for metal processing currently make up about 80% of all requests for supplier matchings. They started to increase in 2018 after the Chinese government began implementing harsh environmental regulations that essentially brought a huge chunk of their heavy industries to a screeching halt. A lot of factories not only in steel-making but also downstream metal processing had to close down. Because the supplier base shrank prices and lead times began to rise. This caused German customers that until then relied almost exclusively on the Chinese market to re-assess their sourcing strategies. This situation is still ongoing and many customers are now looking into Vietnam for alternatives. As another shock, the China-US trade dispute did not immediately disrupt goods exchange between Germany and Vietnam in such a dramatic fashion but led to a further rethinking of supply routes. The current Corona epidemic will most likely lead to even more companies diversifying their country risks as supply shortages are emerging.
Dissatisfaction with Chinese suppliers: In connection with above stated price hikes and rising lead times many of our customers mention a certain dissatisfaction with their current Chinese suppliers. They do not feel as “welcome” as a few years back. Some suspect that this is due to their suppliers growing a lot in terms of company size and output so that they do not depend as much on smaller orders from German SMEs as they did in the past.
Free Trade Agreements: Vietnam has spun a vast FTA network over the past 15 years. It covers all of its major trading partners except for the USA. For German companies with manufacturing operations in China it can therefore be advantageous to source certain components in Vietnam and import them to the “Middle Kingdom” tax-free. Crucially, Vietnam will implement an FTA with the European Union in 2020. This will be beneficial for the costs of products sourced in Vietnam and should therefore accelerate the ongoing diversification of supply routes.
As noted above, Vietnam cannot supplant China as a supplying base. Its industry and average company sizes are much smaller. Vietnam is also missing the vertical industrial integration its northern neighbor can offer. Therefore, most new sourcing operations here will be added to the existing Chinese activities to mitigate individual country risks.
China +1 and Manufacturing Investments in Vietnam
Since 2016, we received over 120 inquiries from German companies evaluating the setup of manufacturing activities in Vietnam. 21 enterprises actually invested here during this period. Most of the requests coming in at our offices have some connection to China. They mainly emanate from production plants and/or regional headquarters located in the there.
These companies are typically mulling “China +1” investments in Vietnam because of the following reasons:
Rising labor costs: Same as with sourcing, virtually all of our customers cite escalating HR expenditures in China as a main reason to evaluate activities abroad. Vietnam naturally seems attractive in this respect because its labor costs are only about one-third of its northern neighbor. However, many investors also value “non-monetary” characteristics of their Vietnamese employees. They often praise their industriousness and their eagerness to learn.
Environmental regulations: In the past years, we had some customers coming in from China and wanting to set up factories for activities such as casting, tanning, surface coating and bleaching in Vietnam. These processes potentially emit a lot of exhaust cases as well as toxic waste or wastewater. German investors typically apply latest technologies to ensure a clean output of their factories. Still, they reported that they can virtually not set up these processes in China anymore. They were evaluating investments in Vietnam for this reason. While it still is possible to invest into heavy and chemical industries here it is far from easy to find locations that are ready to accommodate such enterprises. There have been some significant environmental disasters in the past years that have left local governments extremely cautious. It can therefore be challenging to find a suitable location. All of the above-mentioned enterprises found fitting industrial zones eventually; some with our help. 😊
Diversification: Many German enterprises have their Asia-Pacific manufacturing holdings solely located in China. Some of these are recently noticing an evolving risk from this concentration on one country. This is largely due to recent shocks such as the US-China trade dispute. If these companies add manufacturing capacities in the region they will often implement them outside of China to diversify their holdings and mitigate country risks.
Because the biggest sales market in Asia-Pacific is China and because they maintain long-standing, successful investments in the “Middle Kingdom”, most German companies will not “leave” the country. There is no “exodus” out of China. Most manufacturing investors will add capacities abroad to supplement their Chinese activities or transfer labor-intensive processes to Vietnam to make full use of the country´s comparative advantage.
China +1 strategies are here to stay. The Chinese economy is rapidly evolving and so are supply routes within Asia-Pacific. This opens up tremendous opportunities for developing countries and for enterprises looking to source or to invest there. Feel free to contact us if you have questions about the Vietnamese sourcing and manufacturing investment markets!