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China Plus One February 2013 China Plus One Stuart Witchell Senior Managing Director, Global Risk and Investigations Practice FTI CONSULTING Philippa Symington Managing Director, Global Risk and Investigations Practice FTI CONSULTING February 2013 or the last 20 years, many Western companies have invested in China, drawn by its low production costs and enormous domestic consumer market. But in recent years, the cost advantage has diminished, while other business challenges Fhave emerged. As a result, many companies are looking to exploit opportunities in other growing Asian markets both to hold down costs and to reduce overdependence on China. THE PROBLem — a MATURING proved so alluring to Western compa- THE Solution — DIVE DEEPER EconoMY, RISING WAGES AND nies have diminished. For instance, AND/OR BRANCH OUT DISAPPEARING TAX INCENTIVES China no longer ranks as one of the To hold the line on the cost of doing cheapest labor markets in Asia. A Over the past few decades, global business in China, some multinational shortage of qualified workers has led to corporations have been entering China companies are opening new facilities in wage inflation; 10% in 2012 according to to open factories and launch business- China’s interior, where wages continue Standard Chartered. During the coming es in the services industries. This was to be lower than those on the coast. For years, forecasts suggest that Chinese motivated by an eagerness to access a example, consumer packaged goods labor shortages could grow, in part, booming Chinese market while taking giant Unilever has moved some of its as a result of China’s policy permitting advantage of relatively low production manufacturing facilities for products families to have no more than one costs and wages. such as laundry powder and tea to An- child each. hui, a traditionally agricultural province Initially, Western companies had their located 270 miles up the Yangtze River In addition, some of the most meaning- doubts about doing business in what from Shanghai. Computer maker Hewl- ful tax incentives for Western companies they saw as a risky operating environ- ett-Packard (HP) has taken the same have been eliminated. Since 2009, ment. But over the years, China has approach, spending $3 billion on a lap- most of the tax privileges that foreign taken action to address many of the top factory in Chongqing, a city in the invested enterprises formerly enjoyed issues that concerned Western compa- southwest part of the country. And HP have expired. Although it still is possible nies the most. High-profile arrests have announced in April 2012 that it would to obtain tax incentives in certain in- been made by Chinese authorities to add a printer factory in Chongqing. dustries (e.g., the high tech sector) and show they are serious about cracking Still, while moving to the Chinese inte- regions, the process of obtaining these down on corruption and intellectual rior may help alleviate wage pressures, incentives has become more difficult property theft. They also have stepped there is a tradeoff. It takes longer and to navigate. Meanwhile, despite some up monitoring of exports in certain costs more to ship products from the progress, there remain concerns about sectors to discourage counterfeiting and Chinese heartland to overseas markets. other areas. Enforcement of intellectual to improve the quality of exported toys, For companies such as Unilever selling property rights is inconsistent; there is clothing, footwear, accessories, appli- to the domestic Chinese market, that growing fear of reprisals for business ances and furniture. may not be a concern. And firms like HP decisions against Chinese interests; that make relatively small, high-value there are occasional public protests These actions helped the Chinese products may continue to find that the such as the recent flare-up of anti-Ja- economy expand to become the benefits of moving inland outweigh the pan sentiment that caused widespread second-largest economy in the world costs. But there are many companies in disruption to Japanese businesses; (smaller only than the U.S. econo- other industries that will find it hard to and there is an increased frequency of my). But as the Chinese economy has justify a move away from the coastline. labor disputes. matured, some of the advantages that February 2013 MYANMAR For those companies, it may THAILAND make more sense to branch out VIETNAM by opening production facilities in other Asian countries, includ- MALAYSIA ing Vietnam, Indonesia, Thailand or Myanmar. This China plus One strategy has several benefits: INDONESIA Cost contROL — Workers in these Southeast Asian countries generally are less expensive to hire than Chinese employees. By 2010, China already RISK DIVERSIFICATION — Spreading NEW MARKET AccEss — For an had become the third-most-expensive production across several markets economy such as Myanmar, the world’s labor market in Asia, and labor costs hedges future investment in China by newest frontier market that seems have continued their upward trajec- leaving producers less vulnerable to poised for rapid growth, it can be an tory. A March 2012 survey by Standard supply chain disruptions, currency fluc- advantage to become established in the Chartered shows annual wage inflation tuations and tariff risks in any individual country early. running at 10 percent. market. One of the companies that has adopted this strategy is Intel, which made a big bet on China plus One in 2010, when the organ- ization opened a $1 billion chip plant in Vietnam. As it becomes more expensive to do business in China, these Southeast Asian nations are actively wooing outside investors. Included among the most aggressive self-promoters has been Indonesia, which touts generous tax incentives for Western companies and has launched a marketing campaign that boasts of the country’s low wages and growing workforce. Plus Which One? Deciding Where to Diversify For companies choosing to diversify away from China, the choice of where else to go is not a simple one, with each country presenting its own challenges. There are several key consider- ations when selecting an additional regional outpost, including: LABOR costs — Average labor costs middle group for infrastructure attain- include corruption, lack of accountabili- are similar in China and Thailand but ment, Vietnam, Indonesia and Myanmar ty, low transparency and the challenges are significantly lower in countries such were among the bottom six counties of dealing with a burdensome bureau- as Vietnam, Indonesia and Myanmar. in East Asia. In Myanmar, for instance, cracy. Meanwhile in Thailand, the most But these rates can be misleading since mobile phones and Internet penetration acute country risk is the social instability they can fluctuate widely within coun- rates are both below 5 percent, rolling caused by a deep division between rural tries. In China, costs vary from as little blackouts occur on a daily basis and poor “red shirts” and the mostly urban as $2,000/year in western provinces to many streets regularly flood to knee- middle class “yellow shirts.” Companies $6,000/year in Shenzen, a port city and high levels during the rainy season. operating in Indonesia face a different manufacturing center on the east coast. challenge — the relatively high risk of COUNTRY RISK — Country risk en- terrorism and kidnapping that exists in INFRAstRuctuRE — An Indian think compasses a wide range of social and certain parts of that country. A recent tank published a ranking of East Asian institutional challenges that vary from cross-border risk analysis showed that countries by infrastructure in 2011. one country to the next. In Vietnam, all the Asian alternatives are riskier than While it put China and Thailand in the for instance, the main operational risks China, but that some of them (including February 2013 Thailand, Indonesia and Vietnam) are Table 2), but some markets (such as plant in Thailand, a number of the au- not significantly so. Thailand) have comparable per capita tomaker’s suppliers soon began making wealth, and other markets also have plans for Thai operations, while banks MARKET SIZE — If companies plan to large populations. and other services companies started sell domestically, it makes sense to con- looking for ways to serve what could sider the size and attractiveness of local MAJOR CustoMERS — Sometimes the become a major auto export base. markets, as well as how those markets decision of a single manufacturer has likely will change over the next decade. ripple effects. When Ford Motor Compa- China has the highest per capita wealth ny announced in mid-2010 that it was and, by far, the largest population (see spending $450 million to open a major Table 1 WAge OVeRHeAdS In eMeRgIng ASIA Country Average minimum annual salary Average mandatory welfare Total labor cost (worker, Intl. $) (% against salary) (Intl. $) Bangladesh 798 n/a 798 Cambodia 672 n/a 672 China 1,500 50 2,250 India 857 10 943 Indonesia 1,027 6 1,089 Laos 1,057 9.5 1,157 Malaysia 4,735 23 5,824 Mongolia 2,004 n/a 2,004 Myanmar 401 n/a 401 Nepal 1,889 n/a 1,889 Pakistan 984 7 1,052 Philippines 2,053 9.4 2,246 Sri Lanka 1,619 n/a 1,619 Thailand 2,293 6.9 2,451 Vietnam 1,002 15 1,152 SOuRCe: IMF WORld EconOMIC OuTlOOk Database, OctobeR 2010 MANAGING THE RISKS — FINDING A RELIABLE PARTNER, AVOIDING coRRuption AND SMootHING THE TRANSITION In most cases, a reliable local partner is invaluable for local investors looking to enter a new Southeast Asian market. Clearly, in- vestors should take care to perform thorough due diligence on any prospective partner, not only probing the company’s current and past financial performance but also track record and reputation in both the domestic marketplace and abroad. geographical considerations are important as well, as illustrated by one multinational firm that recently entered Vietnam with the intention of expanding throughout the country.
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