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July 21, 2022
While “Made in China” stamps have ubiquitously appeared on goods sold in the U.S. for decades, continued waves of COVID lockdowns and recent political instability have forced companies to take a step back and re-evaluate China’s role in their supply chains.
Prior to the COVID pandemic, the pressure was already mounting in Chinese offshoring through significant wage increases, higher transport costs, quality control issues, and intellectual property theft. But the foundational issues were revealed in early 2020, as the sudden onset of COVID saw many manufacturing and supplier operations in China slow down and eventually flatline. Suddenly, American companies were left with extreme supply chain dislocation and no foreseeable return to normalized production in sight.
Just as COVID brought supply chain fragility under fire, the war in Ukraine and an increased consumer focus on sustainable materials and ethical production turned up the heat. In our ongoing dialogue with business owners, management teams, and investors, four primary reshoring or “China Plus One” alternatives have emerged, all with unique pros and cons.
For companies deeply entrenched in China, relocating aspects of production to nearby nations in Southeast Asia may seem like a reasonable choice. Venturing into the ASEAN region—which includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam¬—means working inside a middle-class consumer base of about 135 million, an additional 30% compared to the Chinese middle-class market. The recent trade war between the U.S. and China has prompted these countries to introduce a series of new policies designed to bring foreign investment into the ASEAN region. Trade and tax incentives also make this an appealing choice depending on a company’s existing setup—ASEAN has free trade agreements with China, India, Japan, South Korea, and New Zealand. This would make it possible to set up a manufacturing presence in one of the previously mentioned countries and export products back to the U.S. (1)
Bordering Southeast Asia, India presents another alternative. For example, one of our former clients optimized costs by moving a portion of its production from China to India and shipping products to the east coast of the U.S. rather than the west coast.
For U.S. companies looking to bring manufacturing efforts a little closer to home, South America presents a potentially viable choice—and has even seen policy momentum in the U.S. Congress as of late. The Latin American Nearshoring Act, drafted by Congressman Mark Green of Tenn., attempts to bring economic change by pushing for a nearshoring movement in South America. Colombia, Chile, Panama, and Costa Rica have emerged as a core group of challengers for nearshoring, thanks to existing technological infrastructure and close political relationships with the U.S.
However, region-wide political turbulence is South America’s biggest challenge in the push for nearshoring. With protests, feuds, and lax COVID policies abound, it seems that political stability is a necessary hurdle to clear before companies can confidently and meaningfully invest in this region for the long term.
Mexico not only maintains the status of the U.S.’ top goods trading partner, but key negotiation of the United States-Mexico-Canada Agreement replacing the North American Free Trade Agreement has driven elevated production in the country.
However, companies have been somewhat hesitant to nearshore to Mexico as border traffic in years past has resulted in significant delays in getting products out of the country. Although the Biden administration has worked to repair relations with Mexico following a tumultuous period under President Trump, tensions such as labor rights, the energy sector, climate change, and investor protections still exist. Lastly, maquiladoras—low-cost factories in Mexico owned by foreign corporations—present cheaper labor alternatives and tax advantages for those who qualify but have come under fire from consumers for labor exploitation and paying workers below the poverty line. (2)
Prior to COVID, companies including H.P., Samsung, Sony, GoPro, Under Armor, and Nike quietly moved out of China, encouraged by Trump’s “America First” policy. When COVID brought global supply chains under the microscope, companies expedited the process of bringing their production as close to their end-users as possible. Brands like Stanley Black & Decker, Hasbro, and Intel have recently relocated, ending decade-long stints in China. (3)
However, it was not long before companies ran headfirst into a massive roadblock—the American workforce shortage. Local restaurants and retailers were not the only victims of COVID-induced labor issues—many prominent multinational companies have closed domestic locations heavily reliant on labor or looked outside of the U.S. to augment operations. Although the idea of bringing production home rings ideal from a logistical and public relations perspective, human resources realities present an almost insurmountable obstacle. In light of this, many businesses are making new long-term investments into automation, and the concept of robotics and a technology-augmented labor force are making reshoring to the U.S. more feasible every day.
While supply chain dislocation and reorganization have far-reaching and immediate impacts on a company’s operations, employees, suppliers, and customers, companies considering an M&A event or capital raise must also keep the implications for those efforts in mind. Business leaders today are faced with the challenge of developing a broad, diverse supply chain with redundancies that can withstand disruption while also avoiding overly complex and widespread supply chains that can expose them to global risks.
In our recent experience, when investors and buyers evaluate a business and its potential risks, extra diligence scrutiny is placed on companies relying on one international operation or materials source. Suppose a company sources 100% of its raw materials from—or manufactures 100% of its products in—a single foreign country. In that case, investors become concerned with the binary risk that disruption in that market could freeze the company’s ability to do business. On the other hand, companies with a combination of domestic and multinational sourcing and manufacturing tend to be viewed more favorably.
Another added benefit for companies that have successfully opened operations in a new market—they may be more attractive to larger strategic acquirers who have been considering how to implement a similar strategy or have been unsuccessful in operating in that new market. These companies are viewed as more robust platforms for growth, with more reliable supply chains and the ability to optimize component manufacturing based on each region’s core competencies and cost structure.
COVID prompted management teams across nearly every sector to address weak points within their supply chains and reconsider how far their materials sourcing and production efforts had spread across the world. Although Southeast Asia, South America, Mexico, and the United States all present pros and cons of their own, the future seems to lie in a blend of regionalization and leveraging the workforce in neighboring countries to compensate for the labor shortage in the U.S., at least until robotics and automation solutions can advance sufficiently to alleviate that constraint.
There is no “one supply chain fits all” solution—the best fit for your company truly lies in your particular supply chain infrastructure challenges and nuances. Our team is active in ongoing discussions with business owners, management teams, and investors weighing these options regularly, and we are happy to lend our insights as you evaluate your next move—wherever it may take you.
For more information, please contact a member of our Industrials investment banking team:
Senior Vice President
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