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24 Apr

Manufacturing's glass ceiling and Asia's branding woes

A while ago, I wrote a three-part series titled How to get rich without getting lucky (Countries' Edition), where I made the case for the idea that in countries like India who have a surplus of human capital, success comes from getting the most out of that human capital, especially when skills are few.

Consequently, I made a case for promoting human labour-heavy domains like manufacturing over IT services and knowledge work, to yank the country out of poverty.

And it makes sense because as manufacturing shifts to developing countries, it brings economic growth and foreign investment. These investments help improve infrastructure, develop local industries, and contribute to overall GDP growth in the region.

Also, there's a kind of technology transfer that happens. When large multinational companies invest in developing countries, they often bring advanced technologies and management practices with them. This technology transfer can help local industries improve their efficiency and productivity, eventually leading to the growth of the local economy.

And as more manufacturing units are set up in developing countries, the demand for skilled labor increases. This can lead to improved education and training opportunities for the local population, equipping them with the skills they need to work in higher-value industries. And unlike IT service companies that only absorb educated folks who are well-versed in English, large-scale manufacturing can also absorb skilled labour without this huge language constraint.

Having said this, today I wish to cover the other side of the argument, where I propose that manufacturing driven by foreign investment — although the right way to start making use of our human capital — comes with its own glass ceiling.

You see, the growth of economies follows a pattern.

From producing locally and chasing sustenance within its own boundary, a country is encouraged to manufacture finished goods using the raw materials for the world at large; essentially, all of international economics and trade is based on this: an exchange of commodities that a country is either naturally endowed with or has the manufacturing muscle to produce.

But as economies grow, industries and costs of manufacturing grow too. Another way to think about growing costs is to think of them as becoming more expensive.

Hence, in the last five years, we have seen a much-needed shift taking place.

Many International businesses are moving their manufacturing units from China to India and other developing Asian countries.

Here’s one of the cases I read about in the Economic Times:

Foxconn Technology Group, Apple's partner, is planning to invest $700 million in a new manufacturing plant in India to increase local production. The move highlights the ongoing trend of shifting manufacturing away from China due to escalating tensions between the United States and China. The Taiwanese company is known for its flagship unit Hon Hai Precision Industry Co., and will construct the plant on a 300-acre site near the airport in Bengaluru, the capital of Karnataka, India's southern state.

People familiar with the matter stated that the plant will produce iPhone components, and some people claim that the factory could also assemble Apple's handsets in addition to making parts for Foxconn's electric vehicle business. Foxconn's investment is one of the largest single outlays in India to date, indicating China's position as the world's largest consumer electronics manufacturer is at risk.

US-based brands, including Apple, are encouraging their Chinese-based suppliers to consider alternative locations such as India and Vietnam, with the global supply chain being restructured due to the Covid-19 pandemic and the conflict in Ukraine. The Bengaluru plant is expected to generate approximately 100,000 jobs, while Foxconn's sprawling iPhone assembly complex in the Chinese city of Zhengzhou currently employs around 200,000 people, which increases during the peak production season.

However, Covid-related disruptions led to a decrease in production output at the Zhengzhou plant, leading Apple to reevaluate its reliance on China. Foxconn's decision to invest in India indicates that suppliers may relocate production capacity from China faster than previously anticipated.

Similarly, Samsung recently opened its largest research and development centre in Southeast Asia in Hanoi, Vietnam, at a cost of around $220 million. The South Korean electronics giant has been manufacturing in Vietnam since 2008, investing an estimated $18 billion since then and planning to invest more this year. It has 28 electronics factories across 11 provinces in Vietnam, with 25 concentrated in the north and three in the south.

Vietnam’s proximity to China offers electronics manufacturers like Samsung the ability to integrate the region into their supply chains more easily, and the largest deep-sea port in Northern Vietnam, Hai Phong, is linked to surrounding provinces by road and rail, allowing for the development of suppliers. Northern Vietnam also has an abundance of relatively low-cost, high-skilled labour, and Hanoi’s amenities make it an attractive location for workers to live while commuting to factories beyond the city’s borders.

Both these developments are interesting because they create massive employment avenues.

But it also comes at a cost to the nations that are still developing.

Asia's economic development has largely been driven by its ability to offer low-cost advantages to companies operating within the region, which has allowed Asian firms to gain market share from competitors in other regions.

Over the past two decades, Asian countries have attracted a variety of industries, including light manufacturing, electrical equipment, and software development.

However, Western companies have begun to streamline their cost structures by either acquiring Asian firms or outsourcing their operations, which has decreased the significance of low cost as a competitive advantage.

Due to cut-throat competition in many industries, companies have been forced to look for additional measures to survive and grow. For example, in the mobile phone industry, brand owners can achieve gross margins that are double those of contract manufacturers. And despite Asia being one of the world's largest providers of commodity products and housing 47% of the world's manufacturing, many Asian manufacturers produce non-branded products for other companies.

This means that the largest financial value is captured by the manufacturers' customers, primarily driven by strong brand strategies and well-executed marketing programs. This is illustrated by the substantial difference in the proportion of value captured between the Asian manufacturing price and the Western retail price.

For example, a branded sports shoe is produced in Asia for an estimated US$5, sold to the sports shoe brand for US$10, and then sold to consumers in retail stores for US$100 — a twenty-fold increase throughout the product-to-brand value chain. This leaves the Asian manufacturer with only a fraction of the substantial value that consumers are willing to pay for, in addition to the fact that the consumer never comes to know the name of the Asian manufacturer who originally made the sports shoe.

So, while employment and nurturing of new capacity are definite positives of becoming a manufacturing hub, the long-term downsides depict that developing countries in Asia remain dependent on manufacturing and sales targets decided by the more developed countries.

While focusing on manufacturing (like China did) may be good for gaining some much-needed momentum, it is not the end goal. The end goal is the ability to innovate and command pricing power and brand power based on that ability. Businesses in Asia, particularly China who is at the tail end of the curve, is now suffering from the opposite — having great manufacturing prowess but being limited by their ability to create brand value and export culture.

By focusing on manufacturing for export, developing countries can become overly reliant on developed countries for their economic well-being. This can lead to dependency and a lack of control over their economic destinies, as these countries are subject to the whims of global markets and the policies of developed countries.

The development stage of countries can influence business priorities, sophistication, and positioning in the value chain.

As countries and industries move from low to high-tech environments, they often supplement low-cost advantages with a valuable perspective that incorporates brand-building.

This also suddenly made me think of how this is true in the case of startups.

All of my Twitter is talking about innovation from a highly specific Western perspective (typically, USA.) The excitement around Indian startups is limited to people within India.

I understand that startups are at a nascent stage in India yet, but I think we should be wary of not directing all our innovation efforts to serve the demands of established businesses abroad but pay equal if not more attention to nurturing a full stack capability to innovate — manufacturing to brand-building.

That is the future I am excited about.

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