Leveraging on supply chain shifts: 5 things Sri Lanka should know

The COVID-19 pandemic has triggered significant global and regional supply chain shifts. Escalating global trade tensions, falling supply chain costs and the rapid uptake of technology are reversing the globalisation of supply chains from the past three decades when businesses moved to countries- most notably China- that offered the greatest cost and scale advantages. 

COVID-19 has laid bare the problem with over-reliance on producers in China and the fragility of global supply chains, thus accelerating supply chains shifts which were already emerging prior to the pandemic. According to recent estimates, companies in over 80% of sectors experienced disruptions in their supply chains during the pandemic. 

Coupled with increased tariffs due to the US-China trade tension, which puts Chinese products at a disadvantageous position against other competing countries in the US market, and the rising cost of manufacturing – labour and production costs – in China over the past decade, many international companies find China which became the ‘world’s factory’, is no longer the cheapest place to manufacture. 

The same product can now be produced at a lower cost in other places in the Asian region. Chinese companies themselves recognise these risks and are also exploring secondary manufacturing locations in Asia.

Background 

US-China trade tensions have led to a 38% reduction in US imports from China during the first quarter of 2020 compared to 2018/19. The marked decline of imports in 2019 stands out from the upward trend in the flow of goods from China to the US over the years.  As a result, some of the production and trade have shifted from China to other countries. 

For example, US imports increased from Vietnam (52%), other ASEAN countries (26%), and Mexico (7%) – see Figure 1.  Only part of the drop in US imports from China was absorbed by the rest of the world, suggesting that some of the production was reshored to the US. 

It is important to note that companies are not abandoning manufacturing in China, which will continue to be a significant supplier to the world. It is unlikely companies will completely move out of China and relocate to another country.  In fact, recent surveys of US and Japanese companies with operations in China show that most intend to maintain their bases there. In addition to retaining a manufacturing presence in China to maintain access to its large market, companies will also have another production location in a lower-wage economy elsewhere in Asia.

1. Supply chain costs

Increased supply chain costs in China have led to international businesses diversifying production to lower cost countries, especially countries like Vietnam and Indonesia in the ASEAN region, which has preferable access to the Chinese market. This has been brought about by rising wages and a declining working age population in China while increasing costs associated with social and environmental compliance, which have further accelerated shifts from China in a number of industries (textiles, energy, heavy metals, coal and gas, mining, cement, paper, automobile, and consumer goods).

2. Technology adoption

Increased technological adoption will lead to onshoring or reshoring of manufacturing to the US, Europe, China, and Japan. This shift will be most pronounced in high value add industries such as technology hardware and equipment, and semiconductor industries, where regional proximity to markets, access to skilled talent, availability of raw materials, and quality of infrastructure combined with increased productivity from automation, artificial intelligence, and other leading technologies, which will overcome comparative advantages based on labour costs. Policy makers in these developed markets are also mediating to relocate these industries within their national borders or closer to home through incentives and legislation.  

3. Short-medium term supply shifts

International businesses are responding to the above challenges of COVID-19, trade tension, increasing supply chain costs, and technological change by reviewing their supply chain strategies to balance total cost of ownership, resilience, and domestic market size. International companies are reassessing their supply chain strategy and increasingly pivoting their business operation activities to South and Southeast Asia to diversify their risks and exposure while relocating strategic industries closer to home markets.  According to a survey of 3000 international companies in 12 global sectors, 66% of North American, 50% of Asia Pacific (excluding China), and 17% of European companies plan to move supply chains from China.

More specifically, in the short-term, international businesses will build resilient supply chains addressing supply shortages, logistics and changing consumer behaviour. In the medium-term, there would be simultaneous shifts – to localise supply chains or reshoring of production in strategic, high value-added industries (healthcare equipment, technology hardware and equipment and semi-conductor industries) closer to the markets due to national security and tariffs while supply shifts to other countries for non-strategic industries which are affected most by rising production costs in China. Non-strategic industries include; consumer durables and apparel, retailing, automobiles and components, and food, beverage, and tobacco industries (Figure 2).

4. Beneficiaries of supply shifts

ASEAN and India markets will stand to benefit from the supply chain shifts as companies look to diversify their sources of supply as they adopt a ‘'China plus strategy’'. At the same time, location of production out of the region to the US or the EU will have negative effects for Asian countries. Choice of location depends on the cost of manufacturing in the country, industry in question, sound economic fundamentals and stability of the country, reliable infrastructure, sufficient human capital stock and low geopolitical and supply security risk. 

Recent announcements from the US, Japan, the EU, India, and Taiwan are also influencing these supply shifts through tax breaks, low cost loans and subsidies. While a rise in geopolitical tensions may further accelerate the supply chain relocation, shifting politics, high cost of changing installed base, long-term contracts with existing suppliers and Chinese industrial policy (Made in China 2025) could constrain these shifts.

5. Implications for Sri Lanka

These ongoing developments have significant implications for Sri Lanka’s trade and investment agendaand private sector development. Increased focus on resiliency by international businesses in the short-term could filter down to Sri Lankan suppliers and producers.  As such Sri Lanka should be able to respond to international businesses exploring additional, alternate sourcing options, prepare information and data on financial and operational health and plan for changes to contractual terms.

In the medium term, there would be supply chain localisation for strategic industries; these industries are not expected to shift to Sri Lanka in the near future. However, supply chain diversification of non-strategic industries holds promise for Sri Lanka. Consumer durables and apparel, retailing, automobiles and components, and food, beverage, and tobacco industries are sectors of export interest to Sri Lanka. 

In October, the USAID-supported Partnership for Accelerating Results in Trade, National Expenditure and Revenue (PARTNER) and the American Chamber of Commerce in Sri Lanka collaborated to hold a forum to disseminate these findings and commence a process of distilling implications, and strategising the way forward, for Sri Lanka. 

Some of the key messages that came out of the report, and reiterated during this forum were that to take advantage of these shifts in supply chain strategies by international businesses, Sri Lanka should articulate industry specific strategies for ‘why Sri Lanka’; identify areas for improvement within country for investor consideration; and market Sri Lanka as a destination to specific companies seeking to diversify their supply chains. Sri Lanka could stand to benefit from these shifts, if the right policy measures and incentives framework are adopted. 

(This article is based on a report by Deloitte Consulting LLP, ‘Global Supply Strategies: Current Trends & Future Shifts,’initiated by USAID/PARTNER project to provide an understanding of the ongoing and future shifts in supply chain strategies of international businesses to the public and private sectors in Sri Lanka.The article does not reflect the views of USAID or the United States Government.)