The tech industry will need to make a "difficult and substantial" shift away from production in China, according to S&P Global Ratings, but it will do so in short order. By 2025, China's share of global laptop production will have plummeted by 10-20 percentage points, while China's production of the world's mobile phones will shrink 5-15 percentage points, the ratings agency predicts.
India and Vietnam would be the primary beneficiaries of this shift, with Vietnam's command-style Communist government currently far more encouraging than China toward foreign capital investment, which the country keenly needs. India, meanwhile, offers the scope of market size and labor pool needed by tech companies, S&P Global writes in a new report, "Global Tech's Moves From China Will Be Costly ... And Unavoidable."
The transition will be expensive and time consuming -- in S&P lingo, it'll be "credit negative" -- but it will reward companies in the long run, the report states. The pandemic, logistics disruption, export restrictions and geopolitical tensions have revealed the perils of an overconcentration of production in one location.
Mexico, as a lower-cost production center with a free-trade deal into the United States, also stands to benefit from the transition away from China. The United States is offering incentives to build high-tech factories, but it only makes sense for producing high-value goods that require tech know-how and don't demand large amounts of labor, according to the report.
The themes mesh with Wednesday's word that India is now home to more people than China, which I discussed in my last story. India is significantly worse off than China in terms of wealth. But that also means it remains a source of cheap labor to make cheap goods, while China is quickly moving up the tech quality ladder to make higher-value production.
S&P predicts that China's share of global handset production will fall from 70% as of 2021 to 55%-65% by 2025. Chinese factories currently make 80% of the world's laptops, but that percentage will fall to 60%-70% within two years, the rating agency forecasts.
Investors will want to watch how their holdings manage this change. S&P anticipates that diversifying tech production out of China will command much of the focus of top management over the next three to five years. Companies that diversify away from China must handle the change carefully, particularly in terms of public and government relations. Otherwise, they risk losing some of their access to China, which is still a significant source of growth in tech sales.
Companies that already have announced plans to bolster production outside China include Apple's chief supplier, the Taiwanese company Foxconn Technology (TW:2354 and (HNHPF) ), which is setting up a chip-making joint venture with Vedanta (VEDL) in India; its Taipei-based tech-assembly peer Pegatron (TW:4938), which reportedly plans to expand capacity in Southeast Asia and Mexico; and even the Chinese smartphone maker Xiaomi (HK:1810 and (XIACY) ), which is expanding production in India, where it has a sizable market share of cheaper handsets. In addition, the Korean electronics conglomerate LG (KR:003550) inked a deal to invest US$4 billion in Vietnam.
The United States also is encouraging multinationals to build high-end production operations, particularly in chip production, within its borders. Chip foundry giant Taiwan Semiconductor Manufacturing (TSM) , Taiwanese silicon wafer maker GlobalWafers (TW:6488), the Korean tech conglomerate Samsung Electronics (KR:005930) and homegrown Micron Technology (MU) have all announced new factories to make chips in the United States.
High wages inside China had already been pushing clothing and shoe manufacturers out to low-cost locations such as Bangladesh and Sri Lanka. But post-pandemic, there is a rapid push to broaden the base for tech production, which was remarkably concentrated inside China thanks to the country's excellent infrastructure and ecosystem of parts suppliers, assemblers and the like.
Developed markets will require subsidies to make the math work for assemblers and chip foundries. The operating expenses of TSM at its operations in Arizona, where it's building a new plant to run alongside an existing one, are 40% higher than in Taiwan.
"The reshaping of supply chains will likely dampen the profitability of an array of tech firms and their suppliers for the next 3-5 years," the S&P report states. TSM's new fab in Arizona will cost US$40 billion and hit the bottom line as it ramps up to start production in 2026, before the plant delivers dividends down the line.
I would note that this transition isn't a shift to de-globalization, even though there are strong protectionist strains in politics in many nations, including the United States, China and India. It's re-globalization. If anything, the tech-production diversification causes a broader reach of multinational connections, with Apple not simply booking out business class for flights from San Francisco to Shanghai. It also needs tickets to Mumbai, Chennai, Hanoi and Ho Chi Minh City, as well as Kuala Lumpur, Bangkok and Seoul.
There's a difficulty in spreading out operations, as it results in a loss in efficiency compared with doing everything inside one country. Companies may retain redundant capacity inside China in case they encounter production hiccups while ramping up new sites, S&P notes, although I'd imagine production would be repurposed to make goods for domestic sales inside China.
Treasury Secretary Janet Yellen on Thursday called for "constructive and fair" economic ties between China and the United States in a speech in Washington. But are those two terms mutually exclusive? The administration of President Joe Biden has pushed for constructive competition with China. But violations of intellectual property rights by Chinese companies, IP theft, heavy subsidies and favorable lending terms granted to state-owned Chinese enterprises by state-owned banks prevent competition on a level playing field. And many industries, particularly tech services such as apps, remain off-limits to international competitors.
Taiwanese companies may be best-poised to handle this transition. They can avail themselves of Chinese operations but generally have already diversified in other locations. Their slice of the market in electronics manufacturing services is also less complex in terms of training for new staff in new locations than other tech subsectors.
