Global Sourcing Shifts Toward China

Despite concerns over cost, volatility and quality, global procurement professionals are shifting their attention toward China — and away from the U.S., EU and Canada — as a leading sourcing destination, according to an IHS Markit survey. In fact, the share of respondents that plan to increase sourcing in the United States dropped from 44 percent to 32 percent in 2016, the second largest one-year drop in the survey's history.

China is no longer being viewed as merely a low-cost destination for sourcing, explained Paul Robinson, economist at IHS Markit. “As more and more companies source from China and the focus on low cost sourcing becomes less and less, it is becoming clear that China's role in supply chains is shifting to a new level,” he said. The survey signals the arrival of China as a hub, or even the hub, of global supply chains, according to IHS.

China, India, and other nations in Asia were the big winners in sourcing realignment, according to the Trends in Global Sourcing Survey, with each showing strong increases. The developed world, particularly the European Union and the U.S., show the weakest results, with less than a quarter of respondents planning to increase sourcing in either region. A bright spot outside of Asia was the continued growth in Mexico, where 26 percent of respondents are looking to increase sourcing, up from 20 percent a year ago.

Risk is the motivating factor behind this sourcing activity. Commodity prices, supplier viability, and geopolitical concerns lead the myriad risks that sourcing professionals face as supply chains stretch. Fully 91 percent of respondents were either somewhat or very concerned about commodity prices, IHS found. China is still perceived to have a cost advantage over the rest of the world, but companies are also spreading their supply risks over a wider range of geographies. Notably, more materials are sourced in China for manufacturing elsewhere (34 percent) than the other way around (less than 30 percent).

Source: IHS Markit

Cost and quality concerns

Still, sourcing from China is not without peril. Rising costs and quality are the leading concerns regarding China, with nearly half of survey respondents rating wage growth, price inflation, and quality issues as their top three risks. China is also viewed as one of the most volatile regions for sourcing – closely followed by the United States. Risk and volatility aren’t necessarily the same thing, Robinson explained.

“We have identified a trend in the past of companies continuing to source from places that they view as volatile,” he said. “I think a lot of this has to do with an uneven application of volatility and that political uncertainty in the United States is held on the same ground as risk to your workers and property in other countries. Again, given that companies continue to source from these sources of volatility, there is clearly some additional thought being put into the sourcing decision beyond risk [or even cost], unsurprisingly.”

Perceptions of volatility are on the decline in Europe, with the sum of the EU and other Europe falling from 39 percent in 2015 to 28 percent in 2016. India and other parts of Asia have shown an even steeper decline, from a combined 56 percent in 2013 to just 26 percent in 2016. This trend of drastic improvement in India and the rest of Asia is mirrored elsewhere in the survey, most prominently in the regions targeted for increased sourcing.

The pace of offshoring itself abated somewhat in 2016, according to IHS. The share of companies manufacturing more than 80 percent of their products abroad will tick up slightly from 10 percent to 12 percent, but there is little reason to believe that this represents a widespread change in strategy.

There’s no indication that a manufacturing exodus from China is imminent. Few respondents plan to reduce their presence in that region, IHS found. Of those that are, more than half are bringing their manufacturing closer to their home market. A quarter of respondents are seeking other low cost regions.

Commodity prices, supplier viability, and geopolitical concerns lead the myriad risks that sourcing professionals face as supply chains stretch and change, the study concluded. There is a slight shift in sourcing from the United States towards Mexico, India, and Asia, but most companies are taking a cautious approach to sourcing outside of their home region in 2017.

China strives to be self-sufficient

China has been clear about its intentions to become a more self-sustaining manufacturing economy. Those efforts are not progressing as quickly as expected. For example, IHS found that sourcing is highly concentrated in a single region. Of companies sourcing from China, more than 80 percent source from the East region that includes Shanghai and surrounding provinces. Western regions barely register and Northern provinces are seeing less activity.

“Although it is early, it appears that the Chinese government's attempts at shifting manufacturing into the hinterland is not proceeding at great speed,” according to IHS. China is also lagging in its efforts to develop a self-sustaining IC supply chain, according to a separate report.

China’s government has a long-term goal to become self-sufficient with regards to IC devices, according to research firm IC Insights. Its “Made in China 2025” (MIC 2025) plan was published by the China State Council in May of 2015. The milestones in the plan are for China to be 40 percent self-sufficient in IC devices in 2020 and 70 percent in 2025.

IC Insights posits that any percentage less than 100 is not self-sufficient. The lack of just one low-value IC, process material or package type will be enough to stop the entire electronic system from being produced and shipped, according to Without Technology, China’s “MIC 2025” Results for ICs Likely to Fall Woefully Short of its Goals. Funding will not be a problem for the Chinese semiconductor industry, but technology will.

China’s national government has approved approximately $20 billion of funding support for its IC industry programs with almost another $100 billion of possible support coming from local Chinese governments, provinces, and private investors. IC Insights believes that the huge roadblock standing in the way of the success of MIC 2025 is the ability of the Chinese to acquire the IC technology to be used in the newly funded fabs.

The Chinese have had some early success in acquiring companies like ISSI and OmniVision, but most governments are now on “high alert” regarding China’s IC industry ambitions and future acquisitions will be very difficult to complete. Essentially, the window of opportunity for the Chinese to attain IC technology through foreign company acquisitions is now closed, according to IC Insights.

In 2016, IC production in China (including foreign companies) represented 11.6 percent of its $112 billion IC market, up less than two percentage points from 9.8 percent five years earlier in 2011, according to IC Insights. China-based IC production is forecast to exhibit a very strong 2016-2021 CAGR of 18 percent. However, considering that China-based IC production was only $13.0 billion in 2016, this growth will start from a relatively small base.

Given the sheer size of the expected expenditures for new Chinese IC facilities, as well as an expanding presence of foreign IC producers (e.g., Intel, Samsung, etc.), IC Insights believes there will be a significant improvement in the share percentage of China-based IC production through 2025, but nowhere near the levels forecast in the MIC 2025 plan. IC Insights forecasts that this share will increase to 17 percent in 2020 and to 25 percent in 2025 -- less than half of the original MIC 2025 goals.