How to Avoid Common Pitfalls When Diversifying Supply Chains Outside of China
Perspectives
Long before COVID disrupted global supply chains or retailers struggled with excess inventories, companies have been looking to diversify their supply chains outside of China with increasing urgency. From automotive companies to consumer electronics and beyond, our firm has worked alongside some of the nation's largest companies and fastest-growing startups to build more resilient supply chains. However, with decades of experience in Southeast Asia, our firm has also witnessed companies that have struggled in their diversification efforts.
For those looking to expand their supply chains across Southeast Asia or enter a new low-cost market, our firm has outlined the three most common obstacles to success so that you can meet your diversification objectives quicker and within budget.
Not Having a Strategy
Hundreds of companies approach our firm annually asking for help in establishing supply chains outside of China. The reasons cited often vary, but tariffs, rising geopolitical risks, humanitarian concerns, and rapidly changing customer demands are typically at the top of the list as to why a business explores new markets.
While we usually see common themes for why a company is looking to start sourcing in a new market, it is unfortunately rare for companies to have a well-defined ex-China sourcing strategy. Determining if a business is looking to avoid or mitigate tariff exposure or seeking to build more resilient supply chains comes with different requirements and has its own measures for success.
Simply researching a new market is a key first step, but failing to ultimately determine a comprehensive sourcing strategy causes many to falter in this diversification process. To position a business for success outside of China, companies should first ask themselves:
- "Why am I looking to establish a supplier base outside of China?"
- "How does our current global or Chinese supply chain organization perform, and are there opportunities for improvement?"
- "What would we consider a success within the next 12-18 months?"
- "How do we anticipate our needs changing over the next 3-5 years?"
Having Unrealistic Expectations
Regardless of the specific strategic goals a business is looking to accomplish outside of China, companies must also be realistic about the projected ROI and resources required to achieve those objectives.
Too often, companies view these new markets as a sort of lottery ticket, hoping to capture significant cost savings and increased supply chain resiliency with relative ease. Unfortunately, just because a business is new to sourcing from countries such as Vietnam, India, or Cambodia doesn't mean that these markets themselves are new to exporting or that these countries are "where China was thirty years ago."
The fact of the matter is that China made a concerted effort at the governmental level over multiple decades to make international trade relatively frictionless. As such, the general business environment was highly transactional, with few suppliers turning down discussions of new business development. Infrastructure was world-class and able to support both the flow of goods and people. Suppliers generally understood retailer requirements and customer demands, and labor was readily available and cheap.
When transitioning to leading alternative markets, Vietnam, for instance, still struggles with its own infrastructure. Its labor pool is roughly 8% of China's, physical plant capacity is strained, and many key components and raw materials still need to be sourced from China. Meanwhile, India is still working to correct a legacy of bureaucratic red tape, Bangladesh needs to navigate a host of worker rights issues, and Myanmar and Ethiopia contend with civil strife.
These market-specific challenges can certainly impact supply chain operations but are by no means insurmountable. However, businesses need to reasonably take into account market obstacles when looking to diversify supply chains, lest they overestimate potential ROI or incorrectly discount the cost of establishing or managing supply chains in these markets. One must not forget that a successful diversification strategy does not necessarily need to drive outsized cost savings or happen overnight, but rather protect a business in the event of a supply chain disruption and provide increased flexibility over time.
Losing Focus and Not Committing to the Process
At its core, businesses and supply chain leaders need to take a crucial look at where supply chain diversification fits among their list of priorities. With logistics challenges, rising costs, fluctuations in demand, and ESG concerns, executives and supply chain practitioners alike are constantly balancing resources between meeting today's challenges and preparing for tomorrow.
One would be hard-pressed to find anyone who does not believe that supply chain resiliency is key to long-term success, but few are willing to pay for that increase in resiliency, and many lose focus when diversification efforts take longer than anticipated.
As such, companies need to take a long-term view when it comes to supply chain diversification and gain broad-based internal buy-in if they are to be successful. As mentioned, sourcing from China, while far from perfect, is in many ways easier than sourcing from most other low-cost countries. Any transition from one market to another will undoubtedly come with a mix of anticipated and unforeseen challenges, and individuals along the value chain will see the impact of this transition.
To avoid losing momentum, start small and build on success. Not every SKU in a product category necessarily needs to be dual-sourced, and production of critical SKUs does not need to be moved overnight or in full. There can certainly be a sense of urgency around supply chain diversification, as far too many businesses have been complacent over the years in mitigating supply chain risk, but diversification is a process and a marathon, not a sprint.