Series: “Offshore Expansion by Small and Medium Enterprises” Final Part
Dealing With Negative Changes in Local Conditions
(Stay, Go Elsewhere, Go Home)
Dealing With Negative Changes in Local Conditions
(Stay, Go Elsewhere, Go Home)
Vietnam Economic Research Institute (VERI)
SMEs consider various factors in determining which country they will set up their offshore operations, including competitive labor costs, access to low-cost raw materials and resources, foreign investment incentives, few regulations on foreign investment, a large local market, and a comparatively stable political situation. When these factors change for the worse, companies have to consider how they will respond. If the negative impact is minor, firms will try to handle the issue where they are, but if the impact is major, they will consider moving to a country with better conditions, or going home. This is not a simple decision, taken from a global perspective that engages with multiple factors.
1. Small and medium enterprises (SMEs) choose the country in which to set up offshore operations for a variety of reasons, including competitive labor costs, access to low-cost raw materials and resources, foreign investment incentives, few regulations on foreign investment, low local procurement ratios, tariff protection from imports of the same product from other countries, a large local market, a comparatively stable political situation, or because a key client has established operations there. When these factors change for the worse, companies have to make management decisions as to whether they stay put, move to a country where conditions are better, or go home. These are not simple decisions, requiring consideration of a number of issues.
When there is a change for the worse in the conditions that pertained when the firm originally set up offshore, the local operation’s business performance will deteriorate. Recent cases include the following.
(i) The firm took advantage of incentives extended by the local government to manufacture products and export them to Japan and third countries. However, the local government stopped providing those incentives for labor-intensive business and export-oriented manufacturing.
(ii) The firm set up locally because of cheap and abundant labor, or because of cheap raw materials and resources, but economic growth ushered in much higher wages and made it impossible to procure raw materials and resources at competitive prices.
(iii) The country was an ASEAN member at the development stage, so it was protected by higher tariffs than in the developed ASEAN countries, or there were restrictions on product imports or domestic sales by foreign firms, but the removal of such protection or restrictions brought an end to these merits.
(iv) The firm set up locally in response to a request from a key client, but that client’s performance deteriorated and orders stopped coming in.
In cases such as the above, if the change has only a minor impact, firms can absorb it by rationalizing their businesses and re-gearing locally. However, where there is a major impact that can’t be handled within the host country, the firm may shift to a country with better conditions. In that case, nearby ASEAN countries are the usual choice. Returning home is one option, but more companies opt to shift country.
2. With its foreign reserves climbing, China announced around a year ago that incentive measures would no longer be extended to foreign export manufacturers or labor-intensive operations, and that it no longer welcomed foreign investment in these areas. Japanese and many other firms in these categories were expected to shift to Vietnam, Indonesia and other ASEAN countries, but according to one survey, only 10 percent of the relevant Japanese firms said that they wanted to shift from China to another country. Many wanted to stay in China and boost their business efficiency, targeting not just exports but also the Chinese home market. This is an understandable management decision for firms that are already in China, but firms looking at moving offshore for the first time are avoiding China and turning their attention to Indonesia, Vietnam, Thailand, Cambodia and even Bangladesh and Myanmar. Thailand, Vietnam and Indonesia are particularly popular among Japanese firms recently.
Firm A is a manufacturer of work wear and other textiles and garments. Seven years ago, the company built a factory in China. In addition to the above-mentioned suspension of incentives by the Chinese government, China’s labor costs have skyrocketed, causing the company’s business performance to slump significantly. Two years ago, Firm A also set up a plant in Vietnam in a ‘China + 1’ strategy, so it has now decided to scale down the China plant and focus on Vietnam. Over the next three years, it is also considering setting up in Myanmar, which has cheap labor.
3. Under the Common Effective Preferential Tariff (CEPT) mechanism in the ASEAN Free Trade Agreement, Cambodia, Laos, Myanmar and Vietnam will have to drop their intra-ASEAN tariffs to 0-5 percent in 2015 (the developed ASEAN countries did so as of 2010). Products from these countries which have been protected to date by high tariffs will be exposed to competition from other ASEAN countries.
Japanese consumer electronics manufacturers C and D stopped producing consumer electronics in Vietnam and focused production of these models in their plants in Thailand, Malaysia and Indonesia, which are more competitive. As of last year, Vietnam has allowed foreign firms to import and sell products to the domestic market, so Companies C and D have adopted the strategy of establishing sales and maintenance firms in Vietnam and importing their products into Vietnam (at 0-5 percent tariffs) and selling them there.
As of 2018, Vietnam will drop its tariffs to zero for four-wheeled vehicles, which are currently protected by high tariffs. Vietnam’s production scale for such vehicles is around the 100,000 unit mark, with 12 foreign firms (Toyota, GM Daewoo, Ford, Suzuki, etc.) and five local firms jostling for market share. Once tariffs are eliminated, Japanese imports from nearby Thailand and Indonesia will increase, leaving three or four firms making competitive or cheap vehicles, while the others will either have to switch to sales and maintenance or withdraw.
4. SMEs that have moved offshore in response to a client’s request shoulder the major risk that their client will run into problems and orders will dry up. When SMEs set up offshore in response to client requests, clients generally do not provide any guarantees of order volume or business.
Machine tool control software development firm Y set up in Country X, an ASEAN member, in response to heavy pressure from a key client, but barely broke even for the first four years. With Japan’s economy in recession, the client firm’s performance deteriorated and sales plummeted. As a result, Company Y stopped receiving orders. Company Y spent around a year trying to find new clients in Country X, but things didn’t go well and the firm decided to pull out.
5. Some labor-intensive businesses moved into China 10 years ago to take advantage of the cheap personnel costs and abundant labor. However, China’s long streak of strong economic growth has raised the standard of living and wages too have shot up. It has also become more difficult to find workers for labor-intensive operations requiring unskilled labor.
Parts maker Q, a labor-intensive manufacturer, had plants in China and Vietnam, but because personnel costs were skyrocketing in China, facilities there were scaled back and resources concentrated in Vietnam. However, with Vietnam’s inflation rate soaring recently alongside personnel costs and imported materials and equipment, Company Q didn’t like the prospects and looked into setting up in Cambodia and Myanmar, settling on Cambodia for the meantime.
(original article : Japanese)