Updated: Jan 23, 2019
Tariffs. Yes, tariffs matter. At first the main stream financial media reported the tariffs as “small”. Yes, that is a quote. Sounded as ridiculous to many then as it does to everyone now. Many businesses sourcing from China had no choice but to take a wait-and-see attitude; now many are scrambling to look at their options and the impact on long term strategy as their Chinese suppliers have pushed back and made it very clear they will not be absorbing the impact of the tariffs.
Cost Creep in China
“China is cheap.” Compared to what? China is “cheap” compared the US – but that is the wrong comparison, the answer to the wrong question. Manufacturing costs and the cost of doing business in China have increased so much since 2001 that China is no longer the least expensive in the world. On a global level China is more expensive than other nations in Asia, and that is even before considering or factoring in political risk. When considering quality and logistical advantages Mexico may be an option as well.
Intellectual Property Risk and Political Risk
Finally risk is being factored into the equation or at least considered by international companies. Theft of intellectual property continues to be a major cost of doing business in China that is strategic yet somehow often ignored. Boards should be asking why. This risk is dramatically lower in countries such as Mexico; to such an extent that it often only comes up as a point of illustration – there are other risks to manage in Mexico but theft of intellectual property has not been a major one.
Political risk in both China and Mexico is greater in 2019 than it was in 2017. It will become clearer by the summer of 2019 where relatively the 2 nations stand from a risk perspective for US companies.
Summary: The Quick and the Dead
Firms that move quickly to diversify their sourcing and locate alternate manufacturing options will be able to take the greatest advantage of alternatives to China. Those alternatives are limited. Businesses deliberately concentrated production in China, sometimes in the hope or expectation that the internal Chinese consumer market would grow so that they could both export to the US and distribute internally, but as both these multinational corporations and the Chinese government have learned the internal Chinese market did not develop to that extent. The volume of production impacted by the tariffs is so large that the available capacity in East Asia (Vietnam, Thailand, etc.) is not sufficient to replace it. Those that move quickly will gain the most from new footholds. For others it now makes enough business sense to evaluate Mexico as a sourcing option, especially for serving the NAFTA / USMCA markets as well as to take advantage of Mexico’s relative strengths in automotive, heavy truck, and aviation manufacturing.
Middle Market Advisory LLC