China is often on the shortlist for global brands’ design and sourcing headquarters, particularly in FMCG, moderately engineered components, apparel, and electronics. However, there seems to be a sort of ‘catastrophe echo chamber’ regarding China market exits right now. Anything that is not doom and gloom seems almost impossible, so Francis Bassolino, Managing Partner of Alaris Consulting based in Shanghai, outlines the broad contours of four archetypes of MNCs making decisions about China today.
Are multinationals leaving China? This straightforward question has no succinct answer other than no.
A longer, more nuanced response must address the change in thinking over the past decade when China switched from an easy “Yes, let’s invest more. China is a good place to do business”, to the now more negative sentiment: “Maybe it’s time to reconsider options. China is unstable, alien, and unpredictable”.
Since 2008, when China began to flex its muscles in geopolitics and project power abroad, political and business leadership have awakened to realize that China prefers an oligarchical, elite control of all affairs of state. Liberal laissez-faire structures are of limited utility for the Chinese leadership in their effort to achieve their primary aim which is to retain control. China is unlikely on a path to become an ally of liberal democracy.
Indeed, herein lies the root cause of the dilemma for the MNC. Namely, that despite this value mismatch with the average multinational business cultural norm, China is now core to company strategies and cannot be ignored. China is often an essential leg in a three-legged stool that touches ground in Europe, North America, and Asia. Of course, not all feel compelled to be in China. There are good alternatives in Asia and in the near abroad if one is only sourcing. However, for those who want to capture demand intimate engagement is necessary.
We describe why notwithstanding the pressures to disengage, many MNCs have and will likely continue to choose China as a key to their Asia and global strategies.
Public pronouncements often cloud rather than clarify if MNCs are coming or going. For those of us who track public messaging closely, MNCs sound bipolar or schizophrenic. When cornered by the western press, MNCs may refer to the evil China empire. Whereas, while in China performing for a local audience, MNCs can appear obsequious and servile, kowtowing to the CCP, lauding the attractive market and sage leadership built upon 5000 years of history.
But this contradictory behaviour is entirely rational. Survival demands that MNCs sing the song that allows them to get by with the least amount of friction and best access to opportunity. Indeed, to do otherwise is irresponsible. It is an MNC’s fiduciary duty to grow and protect shareholder value.
As such, if one seeks to understand trends, it is necessary to discount overt pronouncements and the theatrics on center stage designed to placate and entertain different audiences. The real plotlines are found in the side shows where intentions are revealed. Accurate indicators of reality and goals are found in trade flows, capital investments, market share and profitability.
And it is within these signals that we find notwithstanding all the pronouncement of decoupling, two markers show little change. First as far as volumes sourced, China is a major link in the supply chain, even when the last point of assembly is elsewhere. For example, trade flows from Vietnam to the US have exploded but Vietnam’s total exports include a sizable portion of value that is added in China. Components produced in China are just assembled in Vietnam, or Mexico.
And second, from an investment perspective, anecdotally and in private conversations, it appears that most MNCs remain cautiously-to-aggressively optimistic about medium-term trends. In short, China is still central to the plot for supply and demand. We just don’t hear or see these pronouncements mainly because investing in China has become sacrilegious. China has metastasized into a third-rail topic best kept out of polite conversation.
Foreign Direct Investment (FDI) may have naturally slowed during the pandemic when travel was near impossible but one year a trend does not make. Suffice is to say that there is certainly no rushing for the exits or wholesale divestiture. Decoupling we are not. MNCs are checking around other markets for cost reduction and diversification of supply chain opportunities, but anyone with a keen and up-to-date understanding of operations is not gunning for the exits regardless of what MNCs might state publicly.
In the rest of this document, we outline the broad contours of four archetypes of MNCs found in China today. We expound on each type to provide detail on the strategies and anecdotes to illuminate market dynamics.
1. China is core to the strategy. We are not going anywhere
BMW, Apple, BASF, and such companies look to China as both a source of supply as well as a significant percentage of sales, growth, and profitability. For example, BMW’s year-over-year China sales grew by 65% in 2022, generating 34% of global revenue, including 900,00 vehicles, of which 200,000 were imports. BMW sourced €15bn of components in 2022. A typical company in this archetype sources 10-20% of supply and generates 15-30% of demand in China.
When China is core to the strategy, MNCs maintain complete, robust organizations in China cultivated over decades. For example, BASF invested about €11bn from 1985-2018. They now manage 67 factories and 12,000 employees. Since 2018, they committed to doubling investment via one of their largest production centers globally which is under construction in Zhanjiang.
Brands that have invested so much are saying, “I'm not going anywhere. This is too important to my business. It's core to my strategy. There's no dictatorship or war in Asia that will make me leave.”
For companies like BASF, sales and often global sourcing functions in China support as well as drive global mandates in the chemical industry. In pharmaceuticals and healthcare, you'll find very similar stories.
For such firms, a move away from China is not decoupling. It would be a dismemberment of the company, a wholesale transformation and change of strategy. Hence, most MNCs like them conclude that it is imprudent to act in haste. And indeed, most scenario planning will conclude that a return to pragmatism and sound economic policy is the most probable outcome. Cold War II scenarios are the redoubt of thinktanks.
In the end, these companies plan for continued albeit reduced growth that will create 93 urban centers with nearly 600 million consumers with an average GDP/capita of Korea.
Look at what Pernod Ricard has done in whiskey in China, but they built a $150 million beautiful distillery in China's southwestern Emeishan with pristine water sources and they didn't screw around on materials. They got the best stuff that was available in the world. They hired the best architects for the construction of China’s "first ever iconic malt whisky distillery". You know, it takes 10 to 20 years to start to sell whiskey. They're not going anywhere.
2. China plus Asia: Diversifying supply away from China, but slowly
For the second archetype, brands are trying to diversify away from China because China, particularly from a demand perspective, is not critical to their business. Supply still is, but not demand.
This second category represented by Home Depot, Walmart, Regal Beloit, and Caterpillar is similar yet different from the previous category in that China is not necessarily critical to the overall operating model except in so much that China sources often drive marginal prices for inputs and finished goods, globally.
Walk through any big box retailer in North America and Europe and it is hard to imagine China not supplying a huge portion of the products that fill the shelves. The same story rings true for industrial goods where the likes of Grainger and Fastenal—distributors who peddle a catalog of hundreds of thousands of industrial parts—would be hard pressed to disengage from China without a fundamental transformation and recreation of their entire supply chain as well as reconstruction of the organization to drive global sourcing.
The typical narrative decrying the end of globalization will often confuse what is happening to this type of company. For example, The New York Times recently detailed furniture maker Man Wah opening a factory in Mexico (pictured below) as a sign of reshoring and diversification away from China. This interpretation while true at face value, confuses as much as it enlightens. Mexico is attractive as a final assembly point for North American markets mainly to avoid tariffs and shorten supply chains. But Man Wah's output in Mexico will be constrained in ways that most articles fail to address with the weight such challenges disserve.
Namely, most manufacturers will not be able to find what they need in Mexico and as such will continue to source many inputs in Asia (and China) for years to come.
What this means for Man Wah is that its cow hides for their leather furniture are sourced in North and South America, then tanned, cut, and sewn in China, and sent back to Mexico (or more likely Vietnam) along with lots of other key components (motors, frames and gears for recliners) made in China for final assembly in Mexico and Vietnam. It took forty years for China to build the deep human and physical capital that undergirds its supply chains. Recreating it elsewhere will take just as long, with more capital as well as a committed institutional and civil polity.
Moreover, when freight rates were $20,000 per container in 2020, Mexico was an easy decision. But these were outlier prices from yesterday’s battle. What happens when freight rates revert to the long run mean of $2,000 per container? And what if tariffs go away? (By the way, as of April, sending a container from Shanghai to LA is less than $1000.)
Yes, Man Wah now has a factory in Mexico. This much The New York Times got right. However, tag yourself to an order and you will be surprised by what you find out about how that product gets designed, prototyped and built. In short, Mexico is a bit part supporting actor. Leading roles will be found in China. This is true for bulky things like sofas and much truer for things that pack more efficiently into containers.
3. No, thank you. The China market does not really appeal to us
Samsung, Google, Facebook, LinkedIn and such firms for political, military, or other reasons have no access to or reason to work with or in China. They may or may not be outwardly negative toward China, (Zuckerberg still blows kisses occasionally) but companies who say they are done with China with such conviction either:
1) Have decided like Samsung that they can’t be profitable in China (couldn’t compete with Xiaomi and Huawei in the android market) and don’t want to be a pawn in Sino-Korean politics, so they exit;
2) Or they don’t want to give up technology to enter the market and/or are just not welcome in China.
Admittedly, there is an extensive list of reasons why companies fail and or exit China. Some of the common reasons include tough competition (fair or otherwise), wrong strategy, leadership and/or structure. The potential reasons are infinite and perhaps remembering Tolstoy helps: “All happy families are alike; each unhappy family is unhappy in its own way.”
4. China is generally not that important to us
There are a few subcategories in this final archetype.
First, “We tried but couldn’t really get it to work. Let’s get someone else to drive for a while”.…. For example, Gap was growing very rapidly in China but was distracted by the collapse of their main market in the US. And the demise of the core business meant that leadership in China was constrained by a lack of capital and unwillingness to invest into a demand strategy that varied from Gap’s traditions.
Namely, in China, Gap needed smaller format stores and seamless coordination with online and offline marketing, sales and fulfilment. Gap recouped $50mn by selling the China business to a local distributor Baozun who will take a run at building the China business. Interestingly, from an arbitrage perspective, companies in this category may have the most potential gain if for example, Gap’s fundamental reasons for failing were things like implementation risk, lack of capital or strategic missteps, not intrinsic value or potential of the product or service.
The second subcategory here is “We tried hard, invested heavily and failed very publicly”. Some of the failures like Carrefour have sold control to local operators. Others such as Home Depot and Best Buy have tried, failed, and exited altogether. Home Depot did not do enough to move toward the “do-it-for-me” preferences of the Chinese consumer. Best Buy was ahead of their time and too impatient to let the market develop an appreciation for their value proposition. Some day we expect many of these companies will return for another try.
Third, “We are here but not really meaningfully feeding the engine what it needs”. Many of the global niche brands such as Aesop or Patagonia fit this description. Such companies could devise strategies and capture significant market share if they would commit to a long game that enters slowly and methodically with a sustained focus on people and capital to adjust to the China demand model. For many brands and categories, Chinese consumers want the products but the “handshake”, the introduction and interaction with the brand, is not approachable or delivered in a consistent way that resonates with the local “taste profile.” There is a lot of capital chasing brands like Aesop trying to realize the value inherent in such brands.
In conclusion, we reiterate that most companies are not decoupling. Most are rethinking and concluding that this market is still worth a long hard look. We continue to maintain a moderately optimistic outlook for MNCs although we think that like in 1989 it may take a few years for the new normal to set in. And like that period, we believe that those that move now will take the lead for the next stage of growth in China.