With the postponing of Mar-a-largo summit on the 14th of March, the hope of a positive outcome in the trade war opposing the United States to China is gradually reducing at a rate of knots for millions of people anxiously waiting. As the U.S. is still the biggest market for China with 478 billion USD in 2018 (19% of China’s exports), it has a major impact on Chinese exportation which explains the drop by almost 21% this February beyond the Chinese New Year effect.
“the U.S. is our main market. So far, on our products taxes only increased by 10%, which was made up by the exchange rate variations. Thus, our US customers agreed on a price increase at the moment but if no solution is found by March it is going to be another story.” Factory owner, Fujian – Nov. 2018
This directly impact U.S. buyers, but not only, as the struggle of Chinese factories uncovers ripple effects for other countries.
Factories service disruptions, factory shut down and subcontracting
In practice, according to the factories we visited in Fujian or Guangdong, some U.S. firms already pull out of China anticipating the tax raise. Which led to a 3.5% slip in the exportation to the U.S. in December 2018 compared to December 2017.
For factories with a consequent share of orders from U.S. customers, it directly translates into a cash flow deficiency later on leading to payment default to the raw material suppliers and possible bankruptcy.
On the top of that, for those which are paying their workers per-piece, the labor force will flee as salaries shrink with orders.
“Orders are decreasing in the region so a lot of migrant workers left to other regions, it will be difficult to find new workers in the future” Factory owner in Minhou, Fujian – Nov. 2018
In an attempt to increase their margins or cope with labor deficiencies some factories might be tempted to subcontract to small workshops in order to stay afloat, with major effects on the quality of the products and the social compliance.
This clearly shows that, with a domino effect, the dynamic is likely to affect a much larger scope of factories than only those dealing with the U.S. Thus, in a proactive move some Chinese factories have already started to divert to other markets.
Refocusing to new markets outside of the E.U.
Every market as a different typology, U.S. clients are known for ordering important volumes at low prices, while European clients are known for smaller volumes and demanding standards. Additionally, in some specific sectors such as decoration and furniture changing your main market necessitate a big effort in reviewing your range of products to match local tastes.
“As you can see, my main range of products is for the U.S. which is totally different with the range for E.U countries. If I need to switch markets, I’d prefer to go for a country with similar taste” Factory owner, Guangdong – Nov. 2018
So eventhough the E.U. countries are an historical market for China, several factories mentioned that they prefer to focus on fast growing markets with important volumes such as Chile. Chile, with which the relations have reinforcing since 2017 and for which the double taxation avoidance came into force in March 2019. Russia also remains a popular option.
Getting new markets is of course a good thing to avoid bankruptcy but as Chinese suppliers turn towards markets with loosen requirements in term of social compliance, there is a risk that the progress we have seen so far in that area fade away.
How to mitigate the risk of domino effect with your Chinese suppliers?
1/ Identify your strategic suppliers in China
The very first thing to do is to re-assess which of your suppliers in China are strategic to you, using a supplier mapping tool. Of course, in order to do that you will want to have a complete list of your production entities in first hand.
For those suppliers that you deem strategic, what is the current market share distribution? If US market share is representative (over 25%), then you need to engage in a dialogue with them in order to assess the risks.
2/ Assess the short and long-term risks for US dependent strategic suppliers
Beyond the factual assessment: Has the situation deteriorated already? Have a lot of workers left? How do they come in terms of production and supply? Understanding the mindset and the ambitions of your suppliers is key. As an example, some factory owners who just don’t want to deal with much troubles, might decide to just shut their business down or subcontract processes. Others will not hesitate to degrade the conditions of their workers to maintain their prices.
Because of that, you should not neglect to ask you factories how they plan to handle their labor force if they experience a temporary slowdown in their turnover.
3/ Mitigate the risk or switch
In case you identify a risk either economic or social but this is a long-term strategic supplier, you probably first want to try to work it out with him, finding solutions that will suit both of you. In case this is not possible you would then decide to switch supplier or find a backup. Take the opportunity to start on solid basis. Beyond the classical due diligence and audit practices establish a more in-depth diagnosis and a transparent dialogue with the factory to better understand the management state of mind, culture and plan for the future. This will save you a lot of time and stress in the future.
Indeed, what the current situation teaches us is that the market is in perpetual evolution, and crisis might happen at any time. So, what makes it easier to cope with changes, is to get to know your suppliers better and establish solid partnership to be able to rely on their pro-activity and innovation skills.