The China Conundrum - are we headed for a supply chain meltdown?

Profile picture for user Jerry.bowles By Jerry Bowles January 24, 2019
Summary:
Is it time for global companies to reconsider their China supply chain strategy? We think that an examination of the issues requires careful consideration.

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In the late 1970s and 1980s, Americans fretted a lot about something called “The China Syndrome.” The idea was that in the case of a nuclear reactor meltdown, the fiery radioactive core would burn a hole through the earth and come out somewhere north of Peking, as it was called in those days.

On March 15, 1979, a Hollywood nuclear disaster film called The China Syndrome was released in theaters across the country and quickly became frighteningly prescient and influential in the nuclear power debate. Twelve days after the movie’s release, America suffered its worse nuclear meltdown ever in reactor number 2 of Three Mile Island Nuclear Generating Station (TMI-2) near Harrisburg, Pa. Most people who know about these things believe the accident set the nuclear power industry back by 40 or 50 years in the U.S. TMI-2 remains closed to this day.

Nowadays, there are growing fears—particularly among global business leaders--of a different kind of meltdown involving China. You might call it "The China Conundrum.” The TL;DR is like this - how dependent do I want my supply chain to be upon China's ability to deliver the goods I sell?

Rethinking the China strategy

Over the past three decades, China has attracted many billions of dollars in investment and outright purchases from Western companies thanks mainly to its enormous labor force and its relatively low cost of manufacturing. Combined with the prospect of gaining a foothold in the world’s biggest market, China has become the go-to source for the cheap electronic parts and components that feed the world’s appetite for affordable computers, TVs, digital games and smartphones.

In recent months, a confluence of events has exposed the potential downside of over-reliance on China and caused large global companies to reconsider their China strategy.

The latest example of the impact of this China Conundrum is the announcement last week that Apple's main iPhone assembler Foxconn is considering building production plants in India as a way to diversify its supply chain away from China, where most of the Taiwan-based firm's facilities currently reside. The Wall Street Journal reported:

Executives at Foxconn, a contract manufacturer that assembles a large portion of the world’s iPhones in China, are studying whether to include an India project in budget plans, one of the people said. Senior executives, possibly including Chairman Terry Gou, plan to visit India after next month’s Lunar New Year to discuss plans, the people familiar said.

Foxconn already has plants in India, and late last year it was reported that the firm would invest around $356 million to expand its facilities there to begin assembling Apple's high-end iPhones. A number of other companies have also announced plans to reduce their China exposure.

Reasons to worry

The main factors driving the China Conundrum are easy to identify but difficult to resolve:

1. Tariffs and Trade Wars - President Trump and President Xi Jinping have pushed their trade war to the brink of disaster. Both countries have seen their stock markets fall and have lowered GDP expectations for the current quarter. Many experts expect the Chinese to make concessions before the next deadline in March that will allow Trump to claim victory but push most of the implementation off until after the 2020 election when there may be a new president.

In other words, the deal is likely to produce a temporary truce and do little to reassure global companies that the issue is truly resolved. Said Stanley Chao, author of Selling to China: A Guide for Small and Medium-Sized Businesses, and managing director of a consulting firm that helps Western companies with their China business strategies:

During the 1990s, I was assisting companies to set up in China. Now, I’m asked to negotiate joint-venture buyouts, employee terminations, and early rental agreement exits. The owner of an auxiliary power-supply company in Shenzhen recently told me, “These China-U.S. tensions are real, and it’s a long-term problem I don’t want to deal with. I want to find other suppliers in other countries and even completely move to another country for manufacturing. It’s just not worth the long-term risk anymore.”

2. Theft of Western technology and intellectual property. China’s state-directed and state-supported efforts to achieve economic dominance by stealing intellectual property from American businesses are well-documented. Two weeks ago, Federal prosecutors announced they are pursuing a criminal investigation of China’s Huawei Technologies Co. for allegedly stealing trade secrets from U.S. business partners, including theft of the tech behind a T-Mobile robot called “Tappy,” used to test smartphones. It’s yet another black mark against Huawei, whose CFO has been detained in Canada and is waiting possible extradition to the U.S. In fact, the U.S. and other countries are barring the use of Chinese-built 5G equipment from Huawei and ZTE thanks to allegations that China's government sabotages those products for espionage purposes. FBI Director Christopher A. Wray emphasized the Chinese threat as the most pervasive.

China’s goal, simply put, is to replace the U.S. as the world’s leading superpower, and they’re using illegal methods to get there. China’s state-sponsored actors are the most active perpetrators of state-sponsored espionage against us.

Back in December, the U.S. indicted two hackers associated with China’s main security service for stealing troves of sensitive digital data from the Navy, the Jet Propulsion Laboratory and 45 U.S. companies as well as American allies overseas. It was simply the latest in a series of indictments aimed at suspected Chinese economic and military espionage.

An American response?

Last week, Congressmen Mike Conaway (R-TX), C.A. Dutch Ruppersberger (D-MD), Jim Himes (D-CT) and Will Hurd (R-TX) Wednesday introduced bipartisan legislation that would strengthen the government’s response to international technology theft and supply chain risks posed by China and others global competitors.

The bill would create The Office of Critical Technologies and Security within the White House to coordinate agencies’ efforts to protect the U.S tech sector. It would create a governmentwide strategy to combat state-sponsored technology threats. The bill comes as the House counterpart to legislation proposed by Sens. Mark Warner, D-Va., and Marco Rubio, R-Fla. Said Congressman Hurd, who has just been named to the House Appropriations Committee:

China’s coordinated assault on American companies, the U.S. government and American intellectual property is part of a broader strategy aimed at attaining leadership in advanced technology and 21st century great power politics. We must continue to hold bad actors accountable.

My Take

Even if the U.S. and China come to some sort of trade truce by the next deadline in March, it seems unlikely that the China-U.S. relationship will return to the days when American companies viewed China as simply a reliable source of cheap labor or potential access to the world’s biggest market. The Chinese have made it clear that they intend to compete with the U.S. in the race to develop advanced technologies like AI and machine learning for both commercial and military uses.

The country’s “Made in China 2025” plan unveiled in 2015 aims to lift the country’s industries- from robotics, aerospace and new materials to new energy vehicles-- up the value chain, replacing imports with local products and building global champions able to take on the Western tech giants in cutting-edge technologies.

At the same time, China is building a digital wall around its own people as a means of both controlling and blocking outside influences. It has also been making threats around the South China Sea that could lead to geopolitical conflict.

It is not hard to imagine that in the new wave of political and economic nationalism that is sweeping the world that the trust gap between China and the West would grow and things will get a lot worse before they get better.

That’s why global CEOs and business leaders need to deal with the China Conundrum now.