Much attention has been paid to the diversification of supply chains away from China in the wake of the pandemic, but new research suggests significant numbers of big multinationals with an established presence there are staying put. In fact, many are actually increasing their investments, not least to gain bigger shares of Chinese markets. This is happening despite growing regulatory challenges and geopolitical tensions.
The trend is the headline finding of recently conducted qualitative and quantitative research by Asia specialists at my company, FrontierView, which advises leading multinationals around the world, including in Asia-Pacific and in China. When our clients were asked where their next big investment would be, 20 percent said China. The figure is down on previous years, but it’s unexpectedly high given the conversation du jour has been about companies relocating to Southeast Asia, or even nearshoring.
Indeed, our research showed that over a quarter of multinationals have invested in additional manufacturing capacity or supplier relationships in China over the past three years.
For many big corporations with a longstanding presence in China, their operations in the country are almost too big to fail – that is to say, too big a percentage of revenue and too big a driver of topline growth. Among these companies, there is very little sign of a desire to close manufacturing and shift production beyond Chinese shores. While some are channeling new investment into supply chain diversification, they are on the whole doubling down on their commercial activities in China. That’s especially evident among European players who do not feel as affected as their American counterparts by the China-U.S. trade war.
In fact, what we’re seeing is large multinationals localizing more of their supply chains in China itself, in large part to increase local market share. In doing so, they rely less, or not at all, on expensive imports into China of parts for products so as to achieve better price competitiveness. That’s important because domestic Chinese players now are able to offer products of comparable quality and cost. The move to improve economies of scale was gaining momentum before the business-disrupting lockdowns of the pandemic – particularly severe in China – and is now much more in evidence, as the Chinese economy slows and deflation bites.
Interestingly, we found that some of the big corporations that choose to diversify part of their supply chains to minimize exposure to the China-U.S. trade war do so without investing in new production plants. Instead, they are collaborating with longstanding Chinese manufacturing partners, who are happy to supply them from elsewhere in Southeast Asia by setting up new, or using existing, subsidiaries, typically in Vietnam and Indonesia.
Given these trends, in the future we are likely to see fewer new entrants into the Chinese market, while players with established operations there will get bigger and stronger, more focused on serving Chinese consumers and businesses. But the transition will be far from seamless, with boards likely raising their scrutiny of new footprint investments in response to growing political and regulatory risks facing Western companies that continue to engage with China.
In this respect, there are interesting comparisons to be drawn with Russia. Large numbers of multinationals have exited the country because of sanctions and reputational threats. Corporations face arguably similar business risks in China, yet, they are more inclined to try to manage these risks because the Chinese market is of greater importance to them. Exit is almost unthinkable given the scale and revenue-generating potential of their operations in the country.
Encouragingly for international companies, China says it remains keen on Western manufacturing investment, despite the ongoing tensions with the United States. It has taken steps to remove restrictions on foreign investment in the manufacturing sector, and President Xi Jinping recently sought to reassure firms that China remained open for business. But on the ground, it has been making the business environment a lot more complex to navigate.
Growth, driven by inward investment, used to be Beijing’s number one priority. Now, with the heightened geopolitical tensions of recent years, China’s government is more concerned with national security. This effectively closes off parts of the economy, making it harder for multinationals to evaluate their risk exposure to the market. It also gives local players a distinct advantage over their western counterparts.
Beijing’s shifting priorities translate, for example, into a wariness of Western investors entering security-related areas of the economy, such as semiconductor, artificial intelligence (AI), and dual-purpose technology industries. Among the measures used to deter such investment are very vague data protection and anti-espionage laws. Implemented at the discretion of the Chinese government, these laws are ostensibly designed to prevent the leaking of sensitive commercial information. The authorities’ closure of the offices of some Western consultancies and due diligence firms has made navigation of such restrictive regulations quite challenging. The tougher regulatory landscape has created a general sense of uncertainty among Western businesses about what they must do to comply.
This has been compounded by the changing geopolitical landscape. Russia’s invasion of Ukraine has raised concerns among boards about the business implications of a possible escalation in tensions between China and Taiwan. The issue has been very high on the agenda of executives in the last year, reflected in an increasing number of contingency planning exercises, particularly around big footprint investments with longer time horizons. The scenario-planning is important because while a catastrophic Chinese military attack on Taiwan is unlikely in the near term, geopolitical tensions could escalate, impacting Western businesses in both Taiwan and China. This could prompt them to reevaluate their investment strategies.
However, there are more immediate challenges in the coming months and quarters: China’s overcapacity and the probable re-election of Donald Trump. Beijing is tackling an economic slowdown by boosting manufacturing. But output exceeds domestic demand, driving down prices, leaving multinationals struggling to compete with cheaper Chinese goods in China and abroad. At the same time, a Trump presidency would double down on trade restrictions, possibly even phase out certain Chinese imports, such as electronics, steel, and pharmaceuticals. U.S. commercial investments in China and federal outsourcing contracts to the country could also be threatened. The consequences for Western companies’ supply chains could be seismic.
For the moment, though, the focus for most multinationals that we work with seems very much on doubling down in China, as rewards generated by expansion appear to far outweigh risks. It’s true that Beijing is making life difficult for Western companies exploring opportunities in sensitive areas of the economy out of their new concerns over national security, but at the same time new opportunities are emerging, such as provincial governments’ receptiveness to Western investment. Geopolitical concerns may in time prompt boards to put a break on operational growth in China, but right now, for some at least, China is practically too big to fail.