COVID-19: Will German Companies Diversify Sourcing and Invest into Vietnam?

In Asia, German companies are highly dependent on their Chinese supply chains. Through the COVID-19 crisis, these have been severely interrupted. We are hence often being asked if German companies are now re-orienting their sourcing strategies by diversifying their holdings in Asia to mitigate supply chain risks. This would culminate in so-called “China +1” strategies whereas Vietnam could play a vital role as an additional sourcing location to the “Middle Kingdom”. We have seen a lot of added interest from German companies through past shocks. It is still too early to judge the effects of the current COVID-19 crisis based on our customer inquiries. However, a recent discussion paper released by Germany’s most influential economics research institute “Ifo” offers many insights into potential future developments in the supply chains of German companies. Based on this paper and few other sources, we will peek into the “crystal ball” and sketch up routes German sourcing could go in the future.

Germany is Extremely Intertwined with Global Supply Chains

Germany and the European Union are deeply intertwined with global supply chains. In 2015, 31% of the German and 28% of the EU value-add of their respective economic outputs has actually originated in third-party countries. This is far more than in China or the USA where only 17% respectively 10% of the added value has originated abroad. In Germany, even complex products such as machinery are highly dependent on foreign input. In 2015, 23% of the value add of the machinery manufacturing has been provided by suppliers from other countries. Same as for Vietnam, China is a leading supply source for the German industry. It added 2.3% of the value-add of the German machinery manufacturers in 2015. Last year, China delivered over 10% of all imported input materials of the German industry. For many goods, this country is the most important – if not dominant – supplier. It is therefore not surprising that the supply chain interruptions due to the COVID-19 crisis first in China and then worldwide are a major challenge for the German industry. According the German Mechanical Engineering Industry Association – VDMA “the current situation must be seen as an economic worst-case scenario (German: “?konomischer Super-GAU”) which has to result in a reassessment of macro- and micro-economic risks.”

So, there is currently a lot of soul-searching going on in the sourcing departments of corporate Germany. Core question is “how do we mitigate supply risks in order to establish more resilient sourcing strategies?”.

Potential Supply Chain Strategies

Optimize Single Sourcing

“Single Sourcing” implies that a company works with just one supplier for certain goods. Because suppliers awarded with contracts will be able to manufacture large quantities of products they can achieve economies of scale which they can pass on to their customers in the form of price reductions. Furthermore, choosing just one supplier reduces the need for communication and thus leads to seamless sourcing processes. Because this approach has proved to be extremely (cost) efficient it has become an integral part of global supply chains. On the downside though working with just one supplier exposes the customer to a lot of risk. If certain suppliers should not be able or ready to fulfill their orders – e.g. through factory closures due to COVID-19 – the customer will be in dire straits.

Now, moving away from Single Sourcing will prove challenging for some companies:

• Customers may have long-standing, well-established relationships with their suppliers. This might be difficult to alter. Also, developing new suppliers takes a lot of efforts, time and costs.
• Some industries have developed into oligopolies with only a few manufacturers without viable alternatives; e.g. in metal processing there are only a few producers in China left for certain processes.
• For small purchase volumes it might be difficult to split them between multiple suppliers.
• Single Sourcing is a proven concept offering too many advantages to ignore.

The current situation nevertheless shows the feebleness of Single Sourcing. Changes will likely happen to mitigate risk. Some experts think that if companies cannot alter their supply chains they should at least increase stock-keeping and reduce just-in-time processes.

Reshoring

Reshoring denotes processes in which out- or off-shored production processes are being retrieved back to the home country of a certain company. Some pundits and scientists believe that current disruptions will bring back production capacities from abroad to Germany and the European Union. Some German media are even hailing the “end of globalization” (see: Der Spiegel or Die Zeit). They believe that multilateralism is at its end and that nation states must be self-sufficient. Certain economists argue that automation and 3D printing will make the retrieval of labor-intensive industries into high-wage countries economically feasible. And indeed, some enterprises such as adidas and General Electric have piloted Reshoring projects.

However, at least in short-term, Reshoring will most likely not happen on a larger scale:

• While it might reduce the reliance of companies on global supply chains it does not necessarily mitigate the risk of disruption within the home country or region.
• New production methods might reduce costs in high-wage countries in the future. However, right now they still tend to be more capital-intensive and overall more expensive than engaging with global supply chains to fully utilize comparative advantages within the world economy.
• Finally, Germany is facing a lack of availability for qualified technical experts. This squeeze would only intensify if Reshoring became a major trend.

Local-for-Local

An alternative to Reshoring could be so-called “Local-for-Local” strategies. This means that companies manufacture close to their sales markets. For example, production for Germany could be done in Eastern Europe or manufacturing for China in – well – Vietnam. Following these strategies, the global supply chains would be much more diversified and regionalized. While Local-for-Local does not achieve the same economies of scale or low pricing as Single Sourcing, it reduces logistics costs and enables companies to swiftly react to changing demand patterns and disruptions.

Indeed, Vietnam has profited for years from Local-to-Local strategies. Many foreign investors use the country as a supply hub for Asia-Pacific. Latest new German “Local-for-Local entry” is tesa which will produce adhesive tapes in Haiphong for ASEAN and China. Tesa says: “Time-to-market is especially important to us. Access to markets, fast and flexible delivery to customers and the development of local raw materials are important factors in international competition.”

Dual/Multiple Sourcing

Creating redundancies within the supply chain by engaging with multiple suppliers for certain input materials could be the “silver bullet” (K?nigsweg) to become more resilient to supply shocks. Over the past view years, we have had many customers from Germany looking for additional suppliers or manufacturing investment locations in Vietnam to complement their activities in China. They are aiming to develop Dual Sourcing (having two suppliers for a certain product) or Multiple Sourcing (having more than two suppliers for a certain product) strategies beyond China. The goal for these clients is to become less dependent on single suppliers or jurisdictions. They may be more flexible in reacting to disruptions plaguing individual suppliers. This kind of strategy is called “China +1”. It is a movement mainly triggered by rising insecurity regarding trade and investment policies as well as escalating labor costs in the “Middle Kingdom”.

However, there are a few setbacks to these diversification strategies, too.

• They are often more expensive than traditional Single Sourcing because sourcing volumes have to be divided between suppliers and thus economies of scale are shrinking.
• Quality and delivery may be inconsistent.
• Companies need additional resources to manage an increasing number of suppliers. This is an extremely important point for small and mid-sized enterprises. Splitting their smaller procurement volumes between suppliers is sometimes not economically feasible.

So, what will happen now?

The COVID-19 crisis may be considered a “Black Swan” event. Its massive effects could not have been eliminated by the above-mentioned strategies. However, for similar future events a certain mitigation of risks is possible if companies prepare accordingly. It can be expected that purchasers from now on will take worst-case scenarios like the COVID-19 crisis into account when calculating risks. There is just one sure thing: Purchasing will become more costly than in the past. Stockpiling, investment diversification and multi-supplier strategies will all come with increased price tags.

Companies will follow diverse paths regarding sourcing strategies fitting to their individual needs. For some, Single Sourcing might be the only feasible option. For others, setting up a diversified supply network with multiple redundancies will be the goal. As Prof. Cohen of Wharton states: “(…) companies seem to be going through very complex (…) trade off and risk analyses. They’re taking into account multiple factors. And depending upon what is dominant in a particular case for a particular product, it could push them in one (…) or the other direction.”

Comparison of supply chain strategies

As discussed above, Vietnam could and will be profiting from an increased significance of “Local-for-Local” and “Dual/Multiple” sourcing strategies. Following these, there most likely will be more sourcing and more manufacturing investments of German companies in the country. The disruptive effects of the COVID-19 crisis in combination with the imminent coming-into-effect of the EVFTA will present a lot of opportunities for Vietnam to fetch more sourcing and investment from the EU and Germany.

For further blog entries please refer to our blog page: https://www.deinternationalvietnam.com/blog

What is your take on this? Do you think we will see more sourcing and investment from Germany and the EU in Vietnam? Let us know in the comments!