The economy of China is evolving. The cost of manufacturing in the world’s most populous country—notably in the coastal regions—is getting more expensive as the skill level of its workforce continues to increase.

Manufacturers, especially those in low-margin industries, have begun to investigate other options for Southeast Asian expansion projects. And there are a number of viable alternative options coming to the forefront to help improve their bottom lines.

“There is always more than one factor, but cost of labor is important,” says Daniel L. Gardner, CEO at RF International and Ocean World Lines, subsidiaries of Pacer International, Inc. “Over time, coastal China and Hong Kong have seen their economies evolve to higher value-added-type industries with higher skills. So, you see a shift away from more labor-intensive industries.”

Those labor-intensive industries, such as textiles, toys, and apparel, are finding new, lower-cost manufacturing homes in a number of countries, including Vietnam, Bangladesh, India, Cambodia, Thailand, Indonesia, and the Philippines. Inland China, hundreds of thousands of miles from the more economically developed coastal region, is also attracting manufacturers in these industries, although logistics times are longer for manufacturers considering plants there.

 

Low costs

Southeast Asian nations have had front-row seats to the development of the Chinese economy during the past three decades, and they’ve seen how the country has been able to attract U.S. and other Western manufacturing investment projects.

Their goal is to replicate, in some way, the success of China.

As a result, many countries have instituted capitalistic practices, shown a willingness to be sensitive to intellectual rights, mandated English as a second a language, and established transportation infrastructure projects to improve logistics. They have joined the World Trade Organization and negotiated free-trade agreements, both regionally and with countries from around the world.

One of the leading advantages for a U.S. manufacturer considering an investment in a Southeast Asian nation is the low cost of land and labor. “There is an ease of doing business and acquiring land, as well as low labor costs,” says Jessica Mahre, VP at A.T. Kearney Analytics and Procurement Solutions Group.

For example, the average productivity adjusted wage for Vietnamese and Thai manufacturing workers is 30 to 35 percent of the average worker wage in the U.S. These wages have historically risen relatively slowly compared with the U.S. overall, especially in contrast to China, says Michael Zinser, a Chicago-based partner at The Boston Consulting Group. China’s productivity adjusted wages are projected to rise by 9 percent per year through 2015; Vietnamese productivity adjusted wages are expected to be flat, and Thai productivity adjusted wages are expected to rise by 4 percent.

 

Stepping up to attract investments

However, these countries do have challenges that manufacturers need to consider in any site-location decision, most notably dramatically smaller working populations. China has nearly 60 percent more industrial jobs than the industrial workforce of Southeast Asia and India combined, Zinser says.

The relatively limited skilled labor pool can quickly be depleted, and competition for scarce labor can lead to high turnover and can increase the risk of wages growing more quickly than projected, he adds.

Infrastructure is more limited in many emerging Southeast Asian nations—for example, Vietnam has only 1/35 the port capacity of China—as political instability is of greater concern, and, in many cases, the supplier network in Southeast Asia is relatively underdeveloped.

Many Southeast Asian nations, such as Vietnam and Cambodia, are focused on relieving the bottlenecks that continue to hamper their supply chain efficiencies. Airport, road, rail, and port infrastructure capacity continues to lag behind demand, although there have been improvements, says Hans Hickler, CEO of the Asia Pacific region at Agility, Inc.

The road network is proving to be a vital artery for manufacturers looking for access to Asian economies and avoiding bottlenecks at ports and airports. Cross-border trucking volumes are growing dramatically as demand increases for door-to-door services.

In addition, many industries, especially producers of products for export, continue to rely on imported materials for spare parts, Hickler says. There is a need for stronger support industries, which would improve domestic competitive capacity, add value to local products, and be essential for strengthening competitiveness in the global economy.

And some countries target specific market segments with incentives and low-cost labor (i.e., apparel in Cambodia and apparel and footwear in Indonesia).

 

More business options

Gardner says when contemplating an expansion project in any Southeast Asian nation, manufacturers need to put the Chinese economy into its proper context. More than 30 years ago, reform efforts initiated by Deng Xiaoping led to “Communism with Chinese characteristics,” especially in South China, and were the launching points for what China can offer international companies today.

China built its economic foundation on low-skilled, low-wage industries. But as the country’s workforce has increased its skill levels, its manufacturing foundation in the coastal areas has evolved into high-skilled, high-wage industries.

That has opened the door for other Southeast Asian nations (and inland China) to compete for the low-skilled jobs that Coastal China no longer wants, Gardner points out.

And he believes other Southeast Asian nations can follow a similar economic evolution path that China has established.

“Every country’s ambition is to rise out of the labor-intensive, low-value-added industries and create higher-paying jobs for more people across a diverse base of industries,” Gardner notes. “It is not too far-fetched to say the economies of [Southeast Asia] can eventually diversify their industries, getting into more highly skilled, value-added manufacturing in the next 10 to 15 years.”

What these Southeast Asians have done is give U.S. manufacturers more options when they are considering an expansion project in the region. More options mean lower costs for the expansion project, leading to a better bottom line.

“In business, you want as many options as you can get,” says Chris Devonshire-Ellis, founder of Dezan Shira & Associates, an independent business adviser and tax consultant. “Companies can keep their business costs lower. There are far more options in Southeast Asia today than there were 10 years ago.” wt

 

Sidebar:

Southeast Asian Nations Look for Business Investments

Here is a sampling of how some Southeast Asian countries are trying to attract Western manufacturers.

 

Vietnam

Lower land and labor costs are part of the attraction of Vietnam. It also has a youthful population, with 50 percent of its residents under the age of 30.

Vietnam has Most Favored Nation status from the U.S.

Because of its Communist government, Vietnam is the Southeast Asian nation that is most closely trying to parallel China. “It still embraces Communism but hasn’t shied away from the principles of capitalism,” says Daniel L. Gardner, CEO at RF International and Ocean World Lines. “The country has taken on the semblance of capitalistic practices.”

The country once had a poor reputation for transportation infrastructure, but that has begun to change with a greater airport capacity throughout the country and new deepwater ports.

“As demand for quality rises, Vietnam has been successful in attracting investment and is developing a reputation for quality higher-end production,” says Hans Hickler, CEO of the Asia Pacific region at Agility, Inc.

 

Cambodia and Laos

Cambodia and Laos are increasingly seen as countries that are ready for business investment, says Chris Devonshire-Ellis, founder of Dezan Shira & Associates. Both countries continue to open up their interiors, allowing access across lands previously unattainable, and they lie directly between the growing consumer markets of Singapore, Thailand, Malaysia, and China.

Cambodia is expected to implement a no double tax treaty agreement (DTA) by the end of 2012, Ellis says. Laos has signed DTAs with China, Kuwait, North Korea, South Korea, Thailand, and Vietnam.

 

India

India’s working population is young, and it is less expensive than China, Ellis says.

The Indian government is trying to push through tax reform, meaning that, eventually, it will be less expensive to operate a facility in India than it currently is, he notes.

Legislation to drop the corporate income tax rate from the current rate of 45 percent to 30 percent is pending. “That will be a major trigger for investment into India,” Ellis says.

This reduction, when added to low labor and mandatory welfare costs, will help India become a serious competitor to China in the bid to attract Western manufacturers.

For the moment, politics is standing in the way of the bill’s passage, Ellis says. Similar to the U.S., India is divided into different states, and an election will occur in India in 2012.

So, the tax reform legislation might not pass until 2013, though Ellis is sure it will become law. “No one will vote against decreasing taxes,” he points out.

 

Indonesia

Indonesia has been successful in recent years because of its political and currency stability, making it an attractive location for expansion projects.

Indonesia is showing significant and sustained improvement from U.S. manufacturers, especially in the apparel industry, where the country offers significant labor cost advantages, as well as good labor skills within specific niches that require more intricate stitching, Hickler says.

 

Inland China

China is putting a lot of emphasis on infrastructure development further inland. Given the high labor rates and increasingly constrained supply of labor available in the traditional Yangtze River Delta manufacturing region, China is investing heavily in inland ports and other infrastructure projects to facilitate easy transfer of goods from inland areas for export, says Michael Zinser, partner at The Boston Consulting Group.