Your China Supply Chain is a Bet Against the House

Last year, I asked my good friend Andrew Hupert of North American Strategic Planning to explain what is involved in moving manufacturing from China to Mexico. I chose Andrew for this because he has spent so much time in both China and Mexico, navigating their manufacturing systems from the inside.

My law firm frequently consulted with Andrew when we first started doing China legal work, and at that time Andrew was living in China. Though Andrew had for decades tied his life and career to China, he — like me — was one of the earliest proponents of a post-China manufacturing world. So much so that Andrew moved to Mexico, reinvigorated his Spanish language skills and began helping companies — especially companies looking to leave China — navigate Mexico. Who better, then, to write about what it takes to leave China (in whole or in part) for Mexico than Andrew Hupert?

Andrew wrote a series of five posts on the differences between China and Mexico manufacturing and I urge you to read all five of these:

Then at the end of last year, we wrote Three Things Everyone Leaving China for Mexico Should Know, as an introduction to what we expect will be a roughly ten part series to be written over the next 7-9 months. This year we (mostly Andrew) have written Three Mistakes We Made in China and Three Things We’ll Get Right in MexicoMexican Supply Chain Management: You’re not in China Anymore, and Five Potential Shocks to your Chinese Supply Chain in 2023.

The below was written by Andrew (with a few revisions and additions by me) and it constitutes our fourth piece in the series.

A. Are You Betting Against the House?

Running your supply chain through China is betting against the house(s), and your story may very well end with that sad old trope – “at midnight I was up a ton, but by morning my credit cards were maxed out and I had to borrow bus fare to get home…”

Financial analysts don’t predict the future. They understand the present. There are three ways they can do that.

1. Follow the industry. Trend analysis.

2. Follow the leaders. Insider/Technical analysis.

3. Follow the facts. Data analysis.

All three forms of analysis are valid, and all three generally lead to similar conclusions.

SMEs with supply chains still in China have seen the trend analysis — a China +1 and/or Nearshoring/Friendshoring took off after October 4, 2018, when the US government explicitly labelled China a “strategic competitor”. We have for some time been seeing the insider analysis on leaving China as an increasing flow of direct investment in production capacity moves into Mexico. The next step is data analysis. Let’s start with three seemingly random and contradictory headlines from last week and see what they could mean for your business.

a. Trade with China Hits Record High

In What cold war? U.S. trade with China hits new high, Politico notes that even though “U.S.-China relations have reached a low point after a Chinese spy balloon was discovered — and shot down — over U.S. territory last week . . . . trade between the United States and China set a new record in 2022 — $690 billion — part of a surge in U.S. trade with partners around the world last year.”

b. Unilever Announces $400 Million Mexico Investment

Per Reuters, Unilever will build a manufacturing plant in the northern Mexican border state Nuevo Leon as part of a $400 million investment in the country over the next three years. This investment will bring in 1,200 new direct and indirect jobs, the company added.

c. U.S. Sanctions Six Chinese Tech Companies Involved with Chinese Spy Balloon(s)

Per CNBC, a new round of U.S. sanctions will target six Chinese aerospace companies identified as supporting the Chinese  military’s reconnaissance balloon program. These companies “join a growing list of companies based in China that the U.S. says pose serious threats to national security.”

B. The End of the Story First

The new lineup of lawmakers in Washington DC will be redoubling their efforts to separate the US economy from that of China, and they are chomping at the bit to go beyond existing tariffs, sanctions, and restrictions against China. Beijing will undoubtedly  follow suit, so companies producing in or sourcing from China are at ever-increasing risk.

Let’s look at the data.

1. Trade Wants to be Free

China is indisputably the easiest option for SME manufacturers, especially those with more of a marketing/branding expertise than a manufacturing orientation.

You want to do business in China. You have a great (albeit hard won) relationship with your factory manager, your sourcing agents, and the rest of your China team – be it real, virtual, or a mix. More importantly, it is all working just fine right now. It wasn’t always this efficient, but after years of relationship-building, negotiations, and endless meetings with suppliers, processers and sourcing agents, your Chinse production facility is firing on all cylinders. You are so proficient with your China business you find it hard to operate anywhere else. Just about everyone and everything you know are in China, and for some of you, China is the only place you really know.

At first you were waiting for the geopolitical storms to blow over, then for things to get back to normal, and then you decided to tough it out and make the hard adjustments you needed to make to keep you operation running and in China – because for your business, being in China and running a profitable business are practically the same thing.

And the top-line trade numbers seem to be backing you up. The latest numbers show a record level of two-way trade between the US and China, which confirm similar trends in investment.

So, it’s settled. You’re keeping your supply chain in China, come what will.

2. MNCs are Diversifying out of China

Multinationals corporations (MNCs) are doing what they must to secure access to US markets. These are the best strategic planners on the planet. If you’ve ever had a conversation with a supply-chain person at a major auto company, you know they have an amazing focus and zeal about efficiency. These are the Lean Production guys, the Six Sigma blackbelts, the Toyota Way disciples. Efficiency is like a religion to them, and they consider unnecessary risk a sin. All-in China manufacture is way too risky for them, and they are piling into Mexico in record numbers. They’re not necessarily leaving China, but they are expanding more and more quickly into Mexico, where most large US manufacturers have always had some presence.

The report that Unilever is committing $400 million to new facilities in Nuevo Leone is just the latest in what has been a series of MNCs expanding their North American production. It’s not just US companies – European, Asian and even Chinese national champions are breaking ground or doubling-down on Mexican production facilities. For MNCs, 100% China supply chains are already the outlier – and managers will have a hard time explaining their decision to remain only in China when the fan inevitably gets hit.

3. The Chinese Spy Balloon and its Progeny

Is it bad? Yes, it is. But for some of the older hands it has a kind of “I’m shocked, SHOCKED to find gambling is going on” [at Rick’s]” vibe to it. This was a completely unforced error by China in a high-stakes game. The event itself is not a big military deal, but it is a huge diplomatic problem, and one could not have picked better fodder for those on both sides of the Ocean who have been pushing for decoupling.

The underlying reasoning does not matter. The data point to watch is how direct actors (i.e.: the U.S. Congress) are using the event. Spoiler alert – cooler heads are not prevailing, and they will not prevail. Cooler heads are being called names and having their patriotism/sanity/manhood questioned by hotter heads. Likely outcome: quick and dramatic regulations that will penalize China and trade with China. Buckle up folks, it’s about to get regulatory. Prepare for newly required paperwork mandated by new regulations. Like declarations that the raw materials in your supply chain are persecution and child labor free. This will likely require YOU asking for some kind of certification or verification process from the government you are implicating in persecution.  It’s not as funny when you tell it in Chengdu.

C. Never Bet Against the House

Washington will continue changing supply-chain economics using any and all means possible, and Beijing will continue answering most new U.S. restrictions with one or more of its own. The big fear is that it will be impossible to track regulatory requirements, let alone process all the information.

The US government has been trying to change the economics of China supply chains since 2015, when the Obama Administration first floated the Trans Pacific Partnership. The Trump Administration slapped punitive tariffs on China and changed the basic relationship between Washington and Beijing from “strategic ambiguity” to “strategic competition” to try to change either China and/or the market. The Biden Administration then upped the ante with a de-facto international embargo on semiconductors and the equipment used to produce them. For the history on all of this (along with predictions that have been borne out), check out Repeat After Me: Trade Relations Between the United States and China Will Only Get Worse

For the following reasons, the fact that the PRC economy has soldiered on, and supply chains are still firmly rooted in China should not be taken as a sign that your steadfast reliance on tested methods has been vindicated.

1. The balloon investigation will almost certainly accelerate the political competition for the title of Most Anti-China. Congress is already passing new laws. If passed, America’s Act (presently working its way through the U.S. Senate) is a strong push to move supply chains out of China in favor of friendly nations in North, Central, and South America. My guess is that we will soon look back on this Act as a reasonable but futile attempt to take considered and logical action to wean the US economy away from China. The new Congress is already sanctioning, penalizing, threatening, and blaming. Sure, they will do their best to damage Beijing, but US companies are closer and easier to hurt. So far, the sanctions are on US exporters selling technology to China. Importers and producers will almost certainly be next, and existing tariffs are seen as mild and ineffective.

2. Beijing will not apologize; it will reply. That’s their playbook, and it works for them. Anti-US sentiment in China is ramping up, and there has been talk of restricting solar panel and lithium battery material exports. Semiconductors are at the core of China’s tech strategy for everything from mobile technology to AI to infrastructure. Many in Zhongnanhai (the part of Beijing housing the CCP bigwigs) think China has been too timid and view the move away from Wolf Warrior Diplomacy as a compromise that was not reciprocated by the United States. Internationally, China will score some wins in Central Asia, Africa, and yes – Latin America, but not among more meaningful actors in Europe (such as the Netherlands or Germany). SE Asia will remain as neutral as possible.

3. China supply chains are facing at least three classes of risk. First is the risk of sudden disruption due to geopolitical events. This risk well known now, and it is rising. It is though avoidable, or at least mitigatable. When the boats stop moving between Ningbo and Los Angeles for any reason,  you will not be able to claim to shareholders, boards, partners, or customers that you had no way of knowing. The data was there; you should have known.

Second, your expensive, hard-won brand reputation is at risk. Made in China has never exactly been a selling point for consumers, but now it carries a stigma.  No matter how broad-minded you might be, big parts of the US are anti-global, anti-China, and anti-outsourcing and the balloon has created a feeding frenzy. Did you see Weathertech’s Super Bowl commercial? Did you, like me, immediately think how perfect its timing was? Were you not at least a bit jealous of how Weathertech and not your company could have a commercial like that, touting its Made in America bona fides? I mean, let’s face it, consumer brands with Made in China labels are at risk – but so are upstream suppliers of B2B clients with near-shored alternatives. See Doing Business with China and Your Reputation Risks.

Last but not least,  you run risks on the China side of your supply chain. Your staff, your technology, and your products are vulnerable to a new wave of anti-US sentiment. The “spontaneous” anti-Japan riots of 2012 will seem like a dance-off compared to what can happen if the trade war spills over into the streets. Back then mobs destroyed Toyotas in the streets. This time, it could get much wilder. Just this morning, the United States Embassy in Moscow instructed all U.S. citizens to leave Russia “immediately.” If the balloon tensions do not soon dissipate, it is possible something similar might come from the Beijing Embassy this year. Many of our clients have China evacuation/exit plans already in place and you should too.

D. Conclusion: Don’t Bet Against the Houses

China supply chains were once good business, but they have been shifting to “necessary evil” for the last five years. Expect them to be considered simple “evil” by mainstream America soon — if not already. The US government could not be clearer about how it views China. The Spy Balloon and its progeny are not just isolated misunderstandings; they look like sparks that are lighting dangerous political fuses in both the United States and in China.

The PRC has a long history of using symbolism (and government induced rioting) to make statements and prove points. See Canada, Japan, Norway, France, South Korea. Beijing might decide to make an example of your country, your industry, your company, or your personnel next.