Forget about lost manufacturing jobs and the social implications. In time, Western high-tech companies and other manufacturers may come to rue their decision to offshore manufacturing to Asian low cost locations. As rivals pop up like daisies in China, some observers in Europe and North America are moving to the conclusion that offshoring was at best a “mixed blessing” and potentially a collective strategic blunder for Western companies; production costs have fallen but tougher rivals have emerged and the supply chain is even more complicated.
With China hounding Western businesses for alleged anti-trust practices and local rivals growing stronger, many of the high-tech industry’s leading companies are feeling squeezed. Companies like Cisco Systems, the world’s biggest data networking equipment vendor, and Qualcomm, a major supplier of mobile phone chips, are in trouble with the Chinese government over anti-monopoly charges or over the security of their products.
Offshoring – a form of outsourcing that involves moving production to a foreign location – help companies reduce their total costs. It has also been credited with fostering improved operating efficiencies and competitive differentiation. However, it also spawned something else: tough rivals, especially in the high-tech sector. Other negative effects of offshoring for Western businesses include the transfer of critical intellectual property from West to East, an elongated and tortuous supply chain that crisscrosses multiple borders, and, more recently, accusations of “monopolist” practices levelled by a Chinese government bent on creating a playing field that is more advantageous for local enterprises.
It’s obvious companies like Apple, Cisco, Microsoft and Qualcomm that have come under Chinese scrutiny in recent months, are facing a tidal change in China. Cisco is especially vulnerable because of Chinese security concerns following allegations of US government spying disclosed by Edward Snowden. It simultaneously faces pressure from Chinese rivals like Huawei and ZTE that are seizing market share locally and globally. In its latest quarter, Cisco reported sales in China tumbled 23 percent, continuing a trend the company has seen for several quarters in emerging markets where it faces stiff rivalry from Chinese networking equipment vendors.
“We saw the impact of economic and geopolitical challenges in China, Brazil, Russia, Argentina, Turkey, and Thailand and in a number of emerging markets that many of our peers are seeing. These declines are reducing our growth by several points from what was expected and typically seen,” said John Chambers, Cisco’s chairman and CEO in a presentation discussing the fiscal fourth quarter results last month. “Though the trends were looking better in the [fiscal] second and third quarters, the emerging countries lost momentum in the fourth quarter. Unfortunately, as we look out, we don’t see emerging markets growth returning for several quarters and believe it possibly could get worse.”
Other bellwether Western electronic OEMs, component vendors, distributors and contract manufacturers, including Alcatel-Lucent, Dell, Ericsson, HP, Juniper Networks, Motorola, IBM, and Microsoft are being buffeted by the kind of competition from China that they didn’t foresee when they began outsourcing and offshoring manufacturing to low-cost Asian locations decades ago. Huawei, for instance, reported $39.5 billion in revenue for 2013 compared with $47 billion for Cisco in its fiscal year ended July 26, 2014.
While Huawei has grown consistently in the last several years, Cisco’s sales have hit a rut, sliding as challenges piled up in Asia and parts of Europe. HP is similarly feeling the heat from Chinese competitors. Lenovo Group, which started out as a provider of contract manufacturing services to Western OEMs, is now one of the largest vendors in the world with $38.7 billion in annual sales. In 2013, the Chinese company vaulted over HP to become the world’s biggest personal computer vendor.
Western suppliers to these OEMs and others in their supply chains – distributors and EMS providers – are equally facing stiff rivalry from start-ups in China. Component suppliers like Qualcomm, which still dominates in the supply of mobile ICs, now have new rivals in China and Taiwan, including MediaTek, RDA Micro and Spreadtrum. North American distributors Arrow Electronics Inc. and Avnet Inc. also have their hands full with competition from Taiwan-based WPG Holdings, founded only in 2005 but now No. 1 in Asia and No. 2 globally with 2013 revenue of $13.7 billion.
Offshoring of manufacturing gave companies like WPG Holdings sales opportunities it would not have otherwise had. With Taiwanese and Western companies shifting production to China, distributors like WPG and contract manufacturer Foxconn leveraged their knowledge of the local environment for competitive advantage over foreign rivals. Foxconn, one of Apple Inc.’s main contract manufacturing services providers, is today by far the biggest EMS provider in the world, with 2013 sales of approximately $312 billion compared with $26 billion for closest rival Flextronics International Ltd.
Was China’s Rise Inevitable?
Just like Russia, it is quite likely Communist China would have on its own wriggled out of the stifling bonds of its planned economic system to join the capitalist world. But what Western enterprises did when they began shifting manufacturing facilities to China starting in the 1980s was to hasten that process. In doing so, however, they also unwittingly handed over crucial information and know-how to individuals that have established and are today creating companies that compete against them in major market segments, including electronics.
Offshoring was one of the catalysts for China’s swift rise within decades to the second-largest global economy. Initially – and continuing for some companies today – offshoring boosted corporate balance sheets and accelerated the consolidation of key economic sectors, including the electronics supply chain; the roster of electronics OEMs fell sharply as a result of acquisitions in critical market segments, including, data and networking equipment, PCs and servers and mobile devices.
On the component side, companies like Intel Corp. went on a buying spree with strategic acquisitions aimed at boosting its position in the market for mobile and wireless devices. In the components distribution market, market leaders Avnet Inc. and Arrow Electronics completely reshaped the sector, whittling down the number of big and medium-size players to only and handful. This is true globally, but not in China. Avnet alone completed 96 acquisitions between 1991 and 2014 while Arrow tacked on 29 acquisitions between 2007 and 2014, many of them in Asia, including China, Japan and India. The two companies are expected to continue adding strategic acquisitions in China, as they hasten the consolidation of what is now the world’s biggest market for electronic components.
Economists and researchers examining the implications of offshoring on the global economy have, in general, concluded it’s a mixed blessing. For Asia, offshoring of production from the West has been a gigantic economy booster. It contributed also to the easing of bubbling unemployment-driven social tensions in countries like China and India, both of which were desperate to find jobs for youths graduating from colleges or leaving interior farmlands for cities.
“Foreign outsourcing in high-tech can be a mixed blessing, helping firms’ profitability but accounting for one-third to one-half of the increase in relative earnings disparities between California’s blue- and white-collar workers,” said Dwight Jaffee, Willis Booth professor of banking, finance and real estate at Berkely’s Haas School of Business at the University of California. In a book titled Globalization and a High-Tech Economy: California, the U.S. and Beyond co-written with researcher Ashok Deo Bardhan and regional economist Cynthia Kroll.
Millions of manufacturing jobs have indeed disappeared in North America and Europe, contributing to high unemployment rates and economic doldrums. In a 2012 paper Justin Pierce of the board of governors of the US Federal Reserve System and Peter Schott of Yale School of Management attributed the decline in American manufacturing jobs to China’s growing profile as an economic power. The granting of permanent normal trade relations (PNTR) status to China by the United States in 2000 contributed further to the decimation of American manufacturing industry, they said.
“In China, PNTR can provide producers with greater incentives to invest in entering or expanding into the U.S. market, raising the level of competition in the United States and putting further price pressure on U.S. producers,” Pierce and Schott said in the report. “In the United States, greater assurance of continued low import tariffs can raise U.S. firms’ expected profit from investments related to finding or establishing Chinese suppliers of inputs and final goods, encouraging local producers of these goods to shrink or exit and discouraging new domestic producers from entering.”
Still, many Western executives today would not concede that the offshoring/outsourcing of manufacturing to companies in China and other parts of Asia has been more of a disaster than a blessing. Why? Because many of these companies are still reaping some of the benefits of offshoring and still believe their presence in Asia would grant them sales access to the large markets – on a population basis – of China, India and other parts of South East Asia.
The portion of sales garnered from overseas markets by Western enterprises have certainly shot up in the last decade. Intel, for example, reported sales of $9.89 billion from China in 2013, up from $8.3 billion in 2012. At IBM Corp., more than 50 percent of the company’s 2013 revenue of $99.8 billion came from outside the Americas division with the Asia-Pacific region contributing $22.9 billion, or about 23 percent. However, the company in its annual filing with the US Securities and Exchange Commission admitted “declines in some of the larger growth markets, for example, China and Australia.”
Sales in China, IBM said, fell “14 percent adjusted for currency”, adding the decline was due to the “process surrounding the implementation of a broad governmental economic reform plan.”
Should Western high-tech companies resign themselves to this negative trend in China or would they eventually see the huge sales they hoped for in the country? The answer to this question depends largely on factors they don’t control, including the Chinese government policy changes referenced by IBM and how effectively they take stay ahead of local rivals in introducing innovative products.
What’s certain is that the field in China and elsewhere globally is now wide open to a much larger group of competitors, many of which Westerners themselves helped to flourish at their own expense.
This is the first in a series of article on the evolution of the global electronics manufacturing market. In the second of the series, we will examine the comparative advantage Western companies still have in the design chain and how Asian rivals are racing to eliminate this edge.