I love the subtitle of the Economist article because the phrasing of this question is exactly how the international lawyers at my law firm typically discuss these various issues with our clients. Should they divest from China (I often refer to this as lightening their China footprint)? Should they decouple from China entirely? Or should they double-down by actually increasing their China exposure?
The short answer, and the one we always give to our clients and on here is a lawyer’s favorite answer: it depends.
But as the Economist article nicely points out, it truly does depend.
1. China is Getting Tougher for Foreign Companies
The article starts out by talking about how bad things have become for foreign companies involved with China and how most expect things to only get worse. Not surprisingly, it talks about how diplomatic spats, consumer boycotts, China’s zero-covid policy and the lockdowns that come from that, recent rioting by Chinese workers, have all “made the country inhospitable to foreign managers.” Surprisingly, it does not discuss the staggering risks foreign companies are facing of a China committed to taking over Taiwan, be that by war or by blockade. To learn more about those risks, I urge you to sign up for our November 30 webinar, The Looming War Over Taiwan and What Businesses Need to Know.
2. Divesting from China
The economist article then discusses how companies like Apple and Hasbro are spreading production to Vietnam and India, “where wages are lower and the operating environment is less likely to induce a migraine,” and how “Bangladesh and Malaysia are becoming more attractive to clothes-makers.” Our international manufacturing lawyers are seeing companies move from China to these countries as well, but also to Mexico, Colombia, Turkey, Thailand, and Pakistan, among others. The toughest thing — and what is stopping so many SMEs from just up and fleeing China — is figuring out what country makes the best sense for each particular company.
The article discusses how in 2019, the French supermarket chain, Carrefour, sold 80% of its China business to a local Chinese retailer, after more than two decades in the country and how Gap Brands earlier this month announced that it would be “offloading” its Chinese business to a local e-commerce company. The article notes that “throwing in the towel while the business is still worth something will probably be the favoured option for firms that have lost their edge over domestic rivals and can afford to live without China.” Our law firm is seeing companies seeking to sell their China businesses now so as to avoid a Russia-like situation where they have to sell their China business later at fire-sale prices.
3. Doubling Down on China
But as the Economist article points out, for many companies, “China is more than just a cheap place to make things”: it also is a huge market in which to sell things. The article notes, and what my law firm sees with our own clients (some of which are mentioned in the article) that the viability/profitability/importance of selling into China is truly all over the map for foreign companies. The article also mentions how an “unlucky subset” of companies that seek to profit from China have already been or risk being “caught in the geopolitical crossfire” as relations between China and the West continue to deteriorate. The article also notes how even companies that “operate outside so-called strategic sectors are hatching contingency plans for a world without access” to China.
The article also reports that foreign companies face (1) “growing competition from local firms”, (2) foreign brands “are losing their cachet”, and (3) Chinese consumers increasingly favor local brands. The article does not discuss how hard it is for foreign companies to find good people willing to work for them in China or how the CCP increasingly discriminates against foreign companies in certain industries.
Despite the China risks, there are foreign companies choosing to double-down on China:
Siemens, a German industrial conglomerate, recently revealed that it is ramping up investment and shifting a significant share of research and development to China in order to “beat the local champions”, according to Roland Busch, the company’s boss. On October 13th VW announced it would invest €2.4bn ($2.5bn) to establish an autonomous-driving joint venture with Horizon Robotics, a Chinese firm.
I have worked with a number of medical products companies that are doing the same thing based on their belief that their technology is better than anything China has and that increasing their China footprint will increase their China sales. And yes, these companies are cognizant of the risks of losing everything or almost everything should China face Russia-like sanctions over Taiwan. See Why NOW Is a Good Time to Double Down on Doing Business IN China, where we described in depth the sort of companies for which doubling-down on China probably makes sense.
4. Decoupling from China
A few months ago, in Foreign businesses want out of China. But breaking up may be tougher than ever, the Los Angeles Times quoted me on how all of our clients would like to stop manufacturing in China:
“Every single one of our clients would like to stop manufacturing in China, and people say, ‘Why don’t they?’” said Dan Harris, a founder of the law firm Harris Bricken, which advises American companies on doing business overseas. “There’s a million reasons why it’s just not that easy.”
I wish I had been a bit more specific in what I told the LA Times because our clients that make money from China (as opposed to those that solely manufacture in China) are less covetous of leaving China entirely. But it is true that virtually every company that makes products in China or has its products made in China for export would like to leave China. It is also true that doing so can be incredibly complicated and expensive. It is also difficult to find and choose the right factory and country when choosing from what has become a veritable smorgasboard.
A few years before COVID we had a client move its manufacturing from China to Vietnam. For years they would tell us how much they preferred Vietnam. To summarize what they would tell us, absolutely everything was better in Vietnam than in China. Then one day, they told us that they would be moving back to China. Needless to say, we were stunned, but their reason made sense. Though they had moved their manufacturing to Vietnam, they were still getting a number of their components from China and oftentimes they would need various components from China at the last minute because of last minute product changes or inventory shortfalls. In those instances, they would need to fly over the components from Vietnam and this caused their costs to increase and that in turn hurt their competitiveness. We have been seeing similar things happen to our clients that have moved their production to Latin America, though both our clients that are there and I believe these problems are really just ‘teething pains” and over time these problems will cease.
The Economist article defines decoupling much differently than I do. I define decoupling as cutting off China entirely, but the article defines it more as what I would call “going full local.” For decoupling the Economist cites to Yum! Brands, McDonalds and “carmakers” that have left China but kept a strong position there. I think the Economist is referring to companies shutting down their China entities and lightening their China footprint by licensing their brand name or their technology to a Chinese company, or perhaps even manufacturing outside China, but using a Chinese company to act as their product distributer in China.
Like I said, I call this lightening one’s footpring in China and our firm recommends this to many of our clients as an ideal mix of maintaining (or even increasing) their China products, while at the same time reducing their China risks. See China’s Slowing Economy and YOUR Business, where we discuss in depth the benefits of reducing your China footprint and how to do so.
What are you seeing out there?
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