In this two-part commentary Supply Chain Matters shares some initial impressions of the Trans-Pacific Partnership (TPP) which has reached the stage of preliminary agreement pending the ratification by member nations. In early October, ministers of the 12 TPP countries announced conclusion of their negotiations regarding trade among what is estimated to represent 40 percent of current global GDP, which is rather significant, especially from a global supply chain context.
In our Part One posting, we shared perspectives on the defining features and summary descriptions of Sections 2, 3 and 4 of TPP.
We continue with pointing out some other important sections for the education of our cross-industry supply chain reading audience.
Section 14- Electronic Commerce
This chapter prohibits the imposition of customs duties on electronic transmissions and prevents TPP parties from favoring national producers of suppliers. TPP members agree to adopt and maintain consumer protection laws related to fraudulent and deceptive online related commercial activities and ensure that consumer protections can be enforced in TPP electronic messaging. To promote more online focused trading network activity, the agreement calls for promoting paperless trading between businesses and governments including electronic customs forms, electronic authentication and signatures for commercial transactions. The parties agree not to require that TPP companies build separate data centers in store data as a condition for operating in a member country, and that source code of software is not required to be transferred or accessed.
This area will surely aide in measures to streamline B2C/B2B business process and customer fulfillment networks. We also view this as potentially removing barriers to facilitating electronic supply chain control tower capabilities spanning both planning and execution visibility and decision-making needs.
Section 18- Intellectual Property Protections
Consistently, one of the more important concerns for firms and their respective value-chains is IP protection. This chapter of TPP is described as making it easier for businesses to search, register and protect IP rights in new markets. It establishes standards based on WTO’s TRIPS Agreement and international best practices. For trademarks, it provides protections of brand names and other signs that businesses and individuals use to distinguish their products in the market.
This section further contains pharmaceutical-related IP provisions that address both innovative medicines and availability of generic medicines.
Section 19- Labor
All TPP parties are noted as International Labor Organization (ILO) members and thus recognize the importance of promoting internationally recognized labor rights. Rights are noted as the right to collective bargaining, elimination of forced labor, abolition of child labor and elimination of discrimination in employment, among other tenets.
There are further acknowledgements to have common laws related to governing minimum wages, hours of work and occupational safety and health. This section will have special meaning to high tech and consumer electronics, high direct labor focused, and general lower-cost focused contract manufacturing focused value-chains.
Section 20- Environment
TPP parties are to share a strong commitment to protecting and conserving the environment and to effectively enforce their environmental protection laws. There is specific language related to the protection of fisheries, endangered species, water and wetlands and marine environment. The parties are to commit to cooperate to address matters of joint or common interest, including areas of conservation and sustainable use of biodiversity along with transition to lower emissions and resilient economies.
Section 24- Small and Medium-Sized Businesses
A special chapter promoting a shared interest for small-and-medium-sized businesses sharing in the benefits of TPP. It includes commitments from TPP members to create user-friendly business practices, provide assistance in accessing new markets and in overall training.
Section 26- Transparency and Anti-Corruption
A rather important section for strengthening good governance and addressing the effects of bribery and corruption practices. It calls for laws, regulations and administrative rulings be publicly available along with consistent enforcement of anticorruption laws and regulations. The section covers areas for both corporate and public officials.
Obviously there is much more to TPP, more than we can cover in a couple of blog posts. Ratification is expected to occur in 2016 as legislators of individual member countries vote approval. We can’t help to speculate that this effort may take-up most of 2016, given the far reaching aspects of TPP.
As we noted in our initial commentary, certain influential nations such as China are not a current member of TPP. That country, instead, is now actively promoting the Free Trade Area of Asia Pacific (FTAAP) as a further alternative. This week, Chinese President Xi Jinping stated: “With various new regional free-trade arrangements cropping-up, there have been worries about the potential of fragmentation. We therefore need to accelerate the realization of FTAAP and take regional integration forward.”
With a significant global and supply chain influencer such as China, representing the other significant portion of global growth, promoting yet another or alternative trans-Pacific focused trade pact, TPP can either be ratified, compelling other nations to join in its tenets, or could be fragmented by conflicting standards.
Industry supply chains are obviously important stakeholders in these major trade pacts and it will be important to keep up to date on these trade developments along with their implications on easier access to new markets, more leveraged use of technology and impacts to existing business practices.
Supply Chain Matters will do our part to keep readers informed of important developments.
The Wall Street Journal is today reporting (paid subscription required) that General Motors plans to become the first auto maker to import and sell Chinese produced automobiles in the United States. The automobile producer reportedly plans to sell the Buick Envision, a midsize sport-utility vehicle early next year.
The report cites informed sources as indicating that the vehicle will be produced in Shandong province, and will add a third SUV to Buick’s model lineup. Initially, GM plans to import a modest number, indicated as between 30,000 and 40,000 Envisions annually, and the move signals a strategic shift and a bold experiment by GM.
The Buick brand is a well-respected and top brand within China, dating back to earlier times when China’s top government officials rode in chauffeured Buicks. The report observes that nearly 100,000 Buicks were sold in China just last month, compared with fewer than 19,000 sold in the U.S.
According to the WSJ report, by adding a third crossover model GM fills a product gap while accelerating efforts to compete with other foreign and domestic based automakers. However, GM officials indicated to the WSJ that this move is not one related to cost-saving. That obviously remains to be seen as this strategy unfolds.
Buick’s most popular SUV offering is the Encore which is currently produced in South Korea. The second model by sales is the Buick Enclave, a large SUV crossover produced in the United States.
The article opines that the arrival of a Chinese produced model is likely to rile the United Auto Workers which caught rumors of such an announcement during the summer. However, the report indicates that the UAW and GM discussed this move during recent labor talks and appear to have come to some understanding.
GM’s latest move obviously represents confidence that a Chinese produced vehicle can meet or exceed the safety and product feature requirements demanded by U.S. consumers. Supply Chain Matters concurs that this strategic move will be closely watched by other industry players. Depending on the outcome and the response from U.S. consumers, we may well observe other China produced vehicles offered to the U.S. market in the not do distant future.
Yesterday, Yum Brands, operator of KFC, Pizza Hut and Taco Bell restaurant franchises and outlets, invoked business media headlines with the announcement that the firm will split-off all of its China based restaurant outlets into a separate publicly traded franchisee based company.
From our Supply Chain Matters lens, the announcement provides two important takeaways for industry supply chain communities.
The first relates to supply chain disruption and risk associated with global expansion, particularly as it relates to current conditions in China. Yum’s operations in China had accounted for nearly half of the operator’s revenues. The firm has been long cited as a fast-food and foreign brand pioneer in investing in China, having opened its first KFC restaurant in Beijing in 1987. Yum reportedly now operates 6900 restaurants across China.
In the summer of 2014 well-known global restaurant brands such as McDonald’s, Burger King and Yum Brands were each named by both Chinese media and food regulatory agencies for offering expired meat products to customers. The expired chicken and beef meat products were traced by restaurant operators to a specific China based supplier, which was affiliated with U.S. based OSI Group, a $6 billion producer of food products. OSI itself had garnered what was reported to be a solid reputation as a quality focused food supplier. Unfortunately however, wide-scale publicity across China and continued regulatory scrutiny hampered efforts to restore consumer confidence. Since that time Yum Brands has attempted to recover from other food safety scares along with the consequent damage to its respective brands within China.
In its reporting, The Wall Street Journal indicates that one of the intents of this proposed split is to insulate the company from the turbulence that has beset its China operations from food-safety scares, stronger competition and Yum’s own operating missteps along the way. However, the operator desires to maintain a stream of future revenue from what remains to be a large and growing market. Hence is the proposed split involving a franchisee and royalty-based framework.
While many details of this proposed split are lacking, the gist of current reports would indicate that current Yum owned outlets across China will be franchised with a royalty arrangement back to Yum. Whether this arrangement includes an exit from supply chain operations within the country is still an open question, but by our view, seems to be a likely possibility. That would in-effect saddle the China operation with the responsibility to maintain or modify existing sources of supply and perhaps re-negotiate existing food and other supply agreements.
The implications of a pioneer such as Yum Brands making such a move is another indication of many troubling challenges that foreign-based brands are struggling with in maintaining operations within the country.
The second takeaway relates to the continuing influence that activist investors have on strategic decisions related to value-chain operations. As the WSJ notes, this week’s news comes only five days after an activist investor who proposed such a split had assumed a Yum board position. That activist investor accumulated a five percent ownership position in May and then lobbied for both a business strategy change as well as a seat on the board.
When a recognized pathfinder elects to punt from owning value-chain operations in China, it is indeed a wake-up call, especially for companies with impatient investors. China represents a vast market potential yet a multitude of complex value-chain challenges and risks, especially in the light of a troubled economy.
I recently came across a report from business network CNBC that had the eye-gripping title; Why US Manufacturers are Nixing the US for China. The premise of this report was that the combination of applied robotics and the devalued yuan are now lowering manufacturing costs for the global manufacturing hub. This was not the only report we have seen that suddenly trumps the new attractiveness for sourcing in China. However, industry sourcing teams need to be cautious and thorough in their positioning and weighting of manufacturing sourcing decisions.
The argument seems compelling. Chinese factories are cutting prices because their costs are going down as a result of devaluation of China’s currency, not to mention that the current downswing impacting China’s economy has motivated many manufacturers to become more aggressive in preserving existing business or seeking additional customers.
The other compelling force noted was the offset of raising direct labor costs by the shift to more automated manufacturing enabled by robotics. However, a recent posting by China Tech provides a different picture or reality, with the headline: The manufacturing boom in Guangdong is over’: Industrial robot makers the latest to get swallowed up by China’s economic slowdown. A senior salesperson of a leading Chinese robotics firm predicts that only 5 percent of current robotics producers will survive in the next two years because manufacturers do not have the available capital to invest in automation. Apparently many Chinese robotic manufacturers set overly aggressive sales targets and did not factor an economic downturn. Declaring that the export-led boom in coastal region Guangdong is over, exports continue to decline every month.
The specific geography of Guangdong is a key since this was the former lower cost direct labor manufacturing region for apparel, footwear, toys and electronics that can benefit from the application of robotics and automation. Instead, manufacturing has shifted to more interior regions of China, seeking lower direct labor costs.
A separate recent article states that the world’s largest contract manufacturer Foxconn, has throttled back its robotics targets to target 30 percent automation in its factories by 2020. Previous reports had cited a 70 percent target. This report indicates that Foxconn’s Chinese factories, including those in Shenzhen, have 50,000 fully functional robots currently operating. Replicating human tasks in high volumes is not as easy as it seems.
While both outlined factors, the devaluation of Chinese currency and the promise of increased automation to offset increasing direct labor costs would appear to be a compelling argument to once again consider China for manufacturing sourcing, we advise caution for manufacturers and retailers.
The primary lesson learned from the initial wave of strategic sourcing decisions that favored China so many years ago was the one-dimensional view that weighted so many industry sourcing decisions. That sole weighting was the attractive cost of direct labor.
Industries have since learned that intellectual property protection, added logistics and transportation costs and the risks inherent within China and across global distribution networks are all added factors. The same holds true for current decisions, but the assumptions have somewhat changed.
More and more manufacturing has moved to the interior regions of China, requiring added logistics and transportation factors. The global transportation industry has its own set of problems. Ocean container carriers are in a race of survival of the fittest, those with the biggest ships, lowest costs and highest revenue potential. Air freight capacity has been dramatically reduced, and existing air service comes with a premium. Last year’s massive disruption involving U.S. West Coast ports provided a lesson in overburdened port infrastructure and increased transportation risks. Supply chain teams must now balance their transportation risks among both U.S. East and West Coast port entries. For Europe based firms, a massive overcapacity of ocean container vessels on the China to Europe segment has yet to shake out as to which multi-carrier network will garner the most leverage in shipping rates.
China’s leaders are desperately trying to move the economy to one of consumption-based vs. the prior export led, and that will drive capital availability. A consumption-based economy places the priority on China’s own manufacturers and service providers to fuel job growth and compete for business within China. The government has identified strategic industries that will fuel China’s economic growth over the next five years and they will have access to advanced research and needed capital. If you happen to compete in these industries, your business risks are magnified, especially if you source within China. Consider the recent challenges of Western brands competing within China, as their supply chains came under attack for poor quality or sub-standard practices.
Technology is a new imperative, particularly in gaining end-to-end and multi-tiered supply chain visibility across global supply networks.
The takeaway of our commentary is to not be swayed by a singular trend or singular factors. Sourcing decisions continue to require a holistic analysis that not only includes the cost of manufacturing, but the various other factors related to landed costs, inventory investment, security of information and added supply chain risks.
A given in today’s increasingly competitive global economy is that change is a constant, and assumptions prevalent today will be different in the not too distant future.
Industry supply chain teams have hopefully learned that strategic sourcing decisions need to stand the test of landed costs, market access, supply chain resiliency and risk mitigation. While China will remain an important and meaningful source of manufacturing and value-chain capability, industry supply chain teams will require a balanced global approach in sourcing, one that spans cost, technology capabilities, IP protection and risk mitigation.
As a follow-up to our prior Supply Chain Matters posting reflecting on high tech executives meeting with the leaders of China and India last week, came the announcement from Boeing of a significant order for new commercial aircraft along with the pending opening of a Boeing manufacturing facility within China itself.
Boeing indicated that it would sell 300 of its new model 737 jets to China. Of far more concern, this deal includes a plan calling for Boeing to team-up with state-controlled Commercial Aircraft Corp. (Comac) in building and operating a single aisle aircraft completion center in China. This announcement came as President Xi Jinping of China visited Boeing’s facilities near Seattle.
While Boeing indicates that the timing of the completion center has not been finalized, Boeing’s labor unions and certain politicians were quick to weigh-in on this announcement. While Boeing stresses that it will not reduce employment on the 737 program in the state of Washington, the current global hub of 737 manufacturing, the announcement did not garner favor with the likes of U.S. Presidential candidate Donald Trump, State Representative June Robinson and the head of Boeing’s labor union representing aerospace workers.
Readers might recall that in 2011, Boeing reached a labor contract settlement with the labor union representing the company’s production workers at production facilities in the state of Washington. Among other tenets in the ratified agreement, Boeing agreed to source the production of its new 737 MAX aircraft, the newest version, within the union facilities in Renton Washington. The union pressed for such a tenet because Boeing had already had plans to ramp-up model 787 aircraft production at the Charleston South Carolina final assembly facility.
In its reporting, The Wall Street Journal indicates that last month, Boeing increased its forecast for commercial aircraft demand emanating from China to 6330 new aircraft over the next 20 years, 70 percent of which are noted as market growth vs, replacement of older aircraft. That figure represents an average annual volume of upwards of 300 aircraft on an annual basis and that is the friction associated with the announcement of Boeing’s first foreign-based final assembly manufacturing site.
Added to these concerns is that state-owned Comac has been developing the C919 to compete with the 737 and the Airbus A320. That aircraft has thus far garnered orders for 500 jets. Airbus operates an assembly plant in Tianjin to produce aircraft destined for China and Asia based carriers.
Boeing indicates that the new facility will paint the fuselage and install seats and in-flight entertainment systems, but yet one wonders whether China’s leaders will accept such lighter areas of manufacturing as a legitimate presence. One might speculate that value-added composition will be an area for ongoing negotiations related to the China based facility. While in-country value-add is often a tenet of large aircraft deals, coexistence with a declared competitor along with general concerns for intellectual property protection and information security compound a decision related to China in the current environment.
Similar to the themes of the high tech sector, Boeing needs access to China’s growing commercial aircraft market, and in order to gain such access, the company must add a China based production presence to its global supply chain flows, regardless of the expected fallout.
Supply Chain Matters provides a follow-up to our prior commentary: high tech supply chains- increased risks associated with global access. In that commentary, we posed the question of balancing the need of high tech firms for increased market access to China’s market with the added risks of intellectual property protection. Leading up to the visit by Chinese President Xi Jinping to the United States last week, prominent high tech firms elected to seek favor and seek new deals with Chinese partners.
The U.S.-China summit managed to yield some significant deals. On Friday, both countries agreed not to direct or support cyber-attacks that steal corporate information for economic benefit. The countries further agreed to cooperate more closely on the investigation of cybercrimes along with the creation of a high-level working group to combat such attacks. However, beyond the agreement are the actions and will of enforcement. President Obama declared: “We (United States) will be watching carefully as to make an assessment as to whether progress has been made in this area.” President Xi declared that the proper approach was to strengthen cooperation to avoid confrontation and politicization of the issue.
Prior to his summit meeting with President Obama, President Xi Jinping hosted an Internet Industry Forum meeting of prominent corporate high tech executives at the Seattle campus of Microsoft. In its reporting, The Seattle Times features a photo of the prominent high tech CEO’s invited to attend. The optics are stark. The CEO of Alibaba, Amazon, Apple, Cisco, Facebook, IBM, Lenovo, among others are shown as participants. U.S. and China based alike. The Times notes: “Based on the attendance for what was essentially a photo-op in Redmond, that tech industry is betting that their future relies on China.”
In conjunction with the Seattle and Washington meetings, Cisco Systems announced a partnership with China based Inspur Group Co. In June, Cisco indicated that it was prepared to invest more than $10 billion in China over the next several years. The irony of the current announcement was that Cisco was the key supplier to help build China’s internal Internet and was later accused of spying on Chinese citizens. Now its CEO declares: “There are certain geopolitical dynamics that we have to navigate.”
As we along with business media has noted, Chinese authorities have informed state-owned companies and agencies to buy more locally owned and produced high tech equipment and that has accelerated the strategic importance of domestic technology. Foreign based high tech companies now have to pick their partners in order to continue to expand revenues in China.
Surely not as a coincidence, India’s Prime Minister Narendra Modi visited Silicon Valley last week and made time to speak with prominent high tech and consumer electronics executives about investments in the country.
Market and technology access along with job-growth needs are all interwoven in moving parts with implications to global product innovation and value-chain strategies. There are no easy answers and thus are the risks, perils and strategy implications that continue to unwind within today’s globally based and far more competitive supply chains.