The news that Apple is asking suppliers to evaluate diversifying their production capacity out of China signals a major shift in how we will be thinking about the globalization of manufacturing in the years ahead.
It heralds the end of a three-decade period during which the opening of major new markets and reduction of tariff and non-tariff barriers fueled unprecedented growth in traded goods and services.
It marks the beginning of a much more regionalized world in which the companies running production supply chains will have to factor in international politics to a much greater degree than before, and not just the cost, speed, and efficiency with which things can be made in a particular country.
Supply chains will need to become geographically diversified. Gone are the days when a company like Apple can rely so heavily on China for most of its production. In the new normal, companies will be obliged to spread production across different bases -- with a distinct production base to serve North America, and another to serve China and the rest of the world. Serving Europe out of China will probably work for a while, as long as Europe can stay out of the trade conflict between China and the U.S. This will keep large scale operations going in China.
Manufacturers will look for low labor costs first and foremost, and they will hope that they can develop a parallel supply base like the one they have in China. Initially this will favor Vietnam and Malaysia, because of the availability of low-cost labor and relatively stable political environments. I think Indonesia and the Philippines could benefit. Indonesia, though hampered by mostly poor infrastructure, has abundant labor. The Philippines has a significant English-speaking population.
Samsung already manufactures phones in Vietnam, but the rush there will push costs up. A rising trade surplus with the U.S. will also make them next on U.S. President Donald Trump's tariff target list. The Philippines is underrated in my opinion. I recently spoke with the CEO of a major industrial components company who has a long-standing and very successful operation there, and he was quite bullish on its prospects.
India could be a winner thanks to its large, young population, though the country's infrastructure shortfalls and the challenges associated with training and deploying a large workforce will cause factory managers to look wistfully back at the "good old days" of scaling production in China.
Another beneficiary of regionalization will be Mexico. Mexico's labor costs are relatively low, and its geographic proximity to the U.S. and open trading relationships with many other countries have already made it a major player in autos, electronics, and increasingly aerospace. It is well integrated into U.S. supply chains and has substantial capabilities in more complex production tasks.
Taiwan faces particularly complex challenges. Taiwanese companies led by Foxconn which formally trades as Hon Hai Precision Industry, Quanta Computer, Inventec and others were pioneers in setting up vast manufacturing campuses in China, while retaining their R&D work in Taiwan.
Taipei has recognized the overdependence on China since the mid 1990s and encouraged diversification to Southeast Asia starting with Indonesia, Thailand, and Malaysia. Expanding later to other countries in the Association of Southeast Asian Nations, Taiwanese companies have recently pushed into Cambodia, Laos, and Myanmar in textiles and footwear, auto parts, and other manufactured goods. Taipei's "New Southbound Policy" is the latest version of this approach.
Taiwan's major electronics companies have been slow to move because of their great success with the China model. Now it looks like their hands will be forced. There have been press reports of electronics manufacturing moving back to Taiwan, but my friends at companies there have refused comment. This small economy of only 23 million would have a hard time fielding the enormous factory labor force its companies enjoy in China.
Beyond the geographic rebalancing, there are major implications for how we think about global manufacturing. First, fragmentation of production means higher costs and loss of scale efficiencies.
Divided component sourcing will be a major challenge. Today China is the sole or dominant source of many electronic components including batteries and flexible circuit connectors. Setting up new sources of supply will take many years, almost as long perhaps as the decade it took China to capture all those suppliers in the first place. The process means qualifying new producers and maintaining multiple production sites. It does little good to move your assembly work out of China if you are still dependent of critical components emanating from the mainland.
The next point I worry about is the fragmentation of standards. In telecom equipment for example, the U.S. market has historically set global standards by virtue of its size and dominance. But the U.S. is no longer the largest market in the world for things like automobiles or smartphones, batteries, or network equipment.
Once we fragment production, it will be easier to break ranks here as well. Huawei's strength in fifth-generation mobile networks and the potential for fragmentation of radio spectrum management policies (long a subject of international cooperation) suggest to me that the Trump administration's push against Huawei and ZTE might actually have an outcome opposite to what the President is expecting. Far from hindering their businesses, it could eventually hand over huge competitive advantages -- and the ability to set standards worldwide.
Finally, removing China from a company's innovation processes could have a serious damaging impact. Many companies rely on a deep bench of suppliers in China to quickly turn out prototypes, or to produce tooling such as molds for plastic injection molding. The Shenzhen ecosystem is popular among startups looking to launch new products quickly. That will not be easy to replace.
I often tell students that business is conducted on a playing field with a set of rules, much like a football game. Over the last 30 years, we have lived in a relatively benign trade environment -- the rules were stable and predictable. That promoted long-term investments in factories and other facilities, even in far-flung locations. Manufacturers built complex supply chains that depended on the relatively unconstrained movement of goods.
The rules are no longer stable. New tariffs and trade restrictions are popping up as a transactional view of world trade mixes with an increasingly tense geopolitical agenda headlined by the strategic rivalry between the U.S. and China.
I fear that the next chapter in the history of globalization will read very differently. For a manufacturer it promises to be far more complicated and costly, and the benefits to consumers and to nations of free trade are likely to be sharply attenuated.
Willy Shih is a Professor of Management Practice at the Harvard Business School
