This month, the chief executive of a company that runs the Performance Bicycle Web store in the United States sent a letter to customers entreating patience for what was a happy problem for the firm - the inability to fulfil orders fast enough, caused in part by increased sales.
As shelter-in-place - or stay-at-home - directives started spreading across the country from March to contain the Covid-19 pandemic, most Americans had little choice but to shop online, leading to a spike in demand for the cycling Web store's products.
However, because the demand surge was coupled with a shortage of workers, as some were uncomfortable about going to work, the e-tailer was not able to deliver the products within the usual timeframe. And even when it was able to hire more staff, it was hit by another problem - product shortage because of the coronavirus outbreak in China that led to factory closures from just before Chinese New Year in late January to late February when factories started reopening.
CEO Kendall Bennett wrote: "Although only a portion of the products we sell come directly from China, many we found have parts or components that rely on their manufacturing, and that has made it difficult to procure enough inventory to meet demand."
While China has opened up, "the shipping lanes were flooded with the backlog of orders that never got out before Chinese New Year", he wrote, adding that he believed "inventory scarcity could last another 60-90 days".
The product shortage problem of an American bicycle shop during this Covid-19 pandemic underscores the importance of China's role in global supply chains, not only as an assembler but also as a producer of intermediate products.
As IHS Markit Asia-Pacific chief economist Rajiv Biswas noted, China - over the last three decades - has established itself as the "factory of the world", playing a key role in global exports of a wide range of industrial materials, intermediate goods and finished products for the global industrial supply chain in many sectors, including textiles, electronic components and engineering products.
Indeed, China is the top manufacturing country in the world and is responsible for 28 per cent of global output. Many countries, especially in Asia, rely on Chinese intermediate goods, said Rabobank senior economist Raphie Hayat. Asian countries import on average 29 per cent of their intermediates from China. For the US, it is 10 per cent.
However, the problem of Performance Bicycle multiplied many times throughout the world has led to what one analyst described as a "clarion call" to diversify supply chains away from China.
In fact, such diversification has already been taking place over the past decade. Rising factory wages have led to many companies gradually shifting their manufacturing supply chain for low-cost goods such as textiles and electronic components away from China. This process accelerated last year as a result of the US-China tariff wars. The massive supply chain disruptions arising from pandemic-induced factory shutdowns will intensify pressures for firms to reassess their reliance on China.
The trade war and Covid-19, said Dr Hayat, "are a bit of a wake-up call for international companies that they might not want all their key inputs to come from one country".
Some governments are getting into the act, providing assistance to their companies to pull operations out of China. Japan, whose carmakers have had to scale back production in February because Covid-hit Chinese factories could not supply needed parts, has earmarked US$2.2 billion (S$3.1 billion) to help its companies move their production away from China. The US is exploring tax incentives and reshoring subsidies to nudge American companies to move out of China.
But these incentives are unlikely to entice many firms beyond those that have already decided to leave. This is because subsidies may be withdrawn in times of fiscal austerity. For companies, what matters more are factors such as wages, skills of the workforce and ease of doing business, and for those looking to sell goods within the country, the domestic market size and growth, said Dr Hayat.
Indeed, most foreign firms have no plans to move out of China because of Covid-19, as surveys by business groups show. Instead, many are finding other ways to build resilience into their supply chains. The reasons for this are myriad.
REASONS FOR STAYING PUT
Commenting on two surveys conducted recently, Mr Alan Beebe, president of the American Chamber of Commerce in China (AmCham China), said last month: "In contrast to some global narratives, our China-based data suggests that the majority of our companies will not be packing up and leaving China any time soon."
AmCham China conducted the two surveys with the American Chamber of Commerce in Shanghai (AmCham Shanghai) - one in October last year and another in March this year - to study the supply chain impacts of the trade war and Covid-19 respectively on US companies operating in China.
The earlier survey of 70 companies showed that less than 20 per cent of responding firms had begun relocating manufacturing outside of China in the prior two years to mitigate the negative impact of increasing tariffs. This is despite 90 per cent of the firms saying their supply chains were affected by the trade dispute.
Instead of relocating, most firms were focused on operational improvements and digital transformation to improve the competitiveness of their supply chains in China. They have also increasingly adopted an "in China, for China" supply chain strategy with respect to manufacturing and sourcing to meet the demand in the China market.
The second survey - of 25 firms from the original group - showed that in the short term, over 70 per cent of firms had no plans to relocate production and supply chain operations or sourcing outside of China because of Covid-19. Only 12 per cent planned to shift production while 24 per cent planned to shift sourcing out of China.
While certain companies in certain industries may diversify away from China or even expand manufacturing operations in the US, given the current climate, "this is a costly, time-consuming and largely irreversible process", Mr Beebe said.
Mr Joerg Wuttke, president of the European Union Chamber of Commerce in China, said a recent survey showed only 10 per cent of European firms were considering leaving China because of Covid-19, while another 10 per cent were considering going to China. "So it's like a revolving door," he said.
That China is able to get a head start in recovering from the global pandemic-induced production paralysis may blunt the push to get out. As OCBC Bank head of Greater China research Tommy Xie noted, "multinational companies may feel lucky their factories in China are the only ones still open in April".
Another reason for companies to stay put: China's huge market with a population of 1.4 billion.
Mr Wuttke pointed out that the China-US trade war had actually led German carmakers BMW and Mercedes-Benz to expand their production of sport utility vehicles (SUVs) in China because the additional tariffs had made their US-made SUVs, which were being exported to China, uncompetitive.
"What will keep us here is that growth potential is just enormous," he said, noting that China's gross domestic product per capita, at close to US$10,000, is just 16 per cent of the US' and 21 per cent of Germany's, leaving plenty of room for growth.
"So where do you want to go?" he asked. "Size matters."
Beyond its huge market potential, China has stronger manufacturing clusters, better infrastructure and higher-skilled workers compared with places like Vietnam, which has attracted firms relocating from China. Also, while some parts of China have become costly for manufacturers, it is less so for less-developed areas such as Zhengzhou, Chongqing, Chengdu and Xian.
And then there is the sheer capacity of China to supply specific inputs on a very large scale that cannot be matched by most individual countries. As one analyst put it: "There are more migrant industrial workers in China than people in Vietnam." (China has 288 million migrant workers; Vietnam's population is 95.5 million).
Given these advantages and the difficulties of moving supply chains, some firms are adopting a "China plus one" strategy, shifting some production out of China for diversification, but not all of it.
ONE OF SEVERAL NODES
There is no denying that the trend of diversification of global supply chains away from China will continue - if not at the speed and scale predicted - as costs rise and spurred on by the trade war and Covid-19.
Some of this is encouraged by China as it seeks to move up the value chain and improve the environment of its cities. As some analysts point out, a move to cleaner, less space-intensive manufacturing will free up land for other uses such as much-needed residential estates.
Some of the diversification will be driven by other governments for security reasons, to move production of critical goods like pharmaceuticals closer to home or to the home country.
Some firms will relocate to other countries in Asia to build resilience into these chains. Even Chinese companies are doing so, noted Mr Xie, adding that regionalisation is a trend that China will pursue. China and Chinese companies need friends, he said, and the region is their first choice, given the large domestic markets and number of skilled workers.
The Economist Intelligence Unit sees the outcome of recent trends as leading to an Asian supply chain network that is less China-focused and more diverse. The same will happen in other regions, so there will be quasi-independent regional supply chains that will provide global companies with a hedge against future shocks to their network.
As Hong Kong-based economist Alicia Garcia-Herrero put it in a webinar recently: "The world is going to move to several nodal points in the global value chains in different continents", and China will be an important, but not the one and only, nodal point.
When this happens - in the long term as supply chains are hard to set up and move - China need not lose too much sleep over it if the country carries out the economic reforms that it has pledged to implement in the wake of Covid-19, including measures to enhance migrant worker mobility and boost domestic consumption. For it will remain an important player in global supply chains, particularly in high-tech industries such as telecommunications, robotics and artificial intelligence. And it should be transitioning to a consumption-led economy from its investment and export-oriented one now.
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