China: In China, For China – Limiting Tariff Risks, Serving Chinese Consumers

Last Updated: 10 October 2019
Article by Alexander Chipman Koty
  • American manufacturers based in China are increasingly redirecting their focus towards primarily selling to the Chinese market, or being "In China, For China".
  • China's position as the world's second largest economy and touted to be the largest retail market is the appeal for existing investors, even those exposed to tariff costs from the US-China trade war.
  • China's sophisticated manufacturing and logistics infrastructure ensures it will not get replaced in the global supply chain.
  • Foreign investors diversifying their sourcing and production away from China are not exiting the country.

With the US-China trade war well into its second year, foreign investors are increasingly adopting long-term strategies to cope with the tensions.

When the tariffs first went into effect, businesses scrambled to find ways to reduce their immediate exposure to tariffs, such as by taking advantage of the first sale rule, passing on increased costs to suppliers, and other short-term tactics.

Now that it has become clear that a trade deal is not close to being completed and that economic and tech competition is the new normal of US-China relations, foreign investors are developing strategies to fundamentally reassess the nature of their China operations.

One popular concept that has arisen out of this is the In China, For China strategy.

In a recent survey conducted by the American Chamber of Commerce in Shanghai (AmCham), over half of US businesses polled said they were adopting this strategy. Even European firms, generally less exposed to the US-China tariffs, are increasingly implementing the strategy as well.

In short, In China, For China essentially means that foreign investors are reorienting their China investments to serve Chinese consumers rather than international ones. Instead of using China as a production base for export-led manufacturing, foreign investors are producing their goods specifically for local consumption.

This strategy is made possible by China's enormous – and still growing – domestic consumer market. But it also marks a sudden and significant shift for the country that has long been known as "the factory of the world".

Accessing China's domestic consumer market

The In China, For China strategy is predicated on the size of China's domestic consumer market.

What initially made China so popular for foreign direct investment was its enormous labor pool, which could mass produce goods destined for export markets at a large scale for a low cost.

Today, China's labor force still earn considerably less than their counterparts in developed countries, while at the same holding advantages in experience and efficiency compared to lower cost emerging markets. The scale of China's manufacturing sector also allows firms to easily source goods, and highly developed infrastructure allows products to be transported efficiently.

These traits continue to make China a competitive location for export-led manufacturing, even if costs are higher than before. Nevertheless, what lies at the core of In China, For China is not the country's comparative advantages in manufacturing, but the ability to directly access its consumers as an end market.

As the world's second largest economy, with a population approaching 1.4 billion, it is easy to see why China is such an important market for global businesses. Last year, for example, total retail sales of consumer goods hit RMB 38 trillion (US$5.34 trillion), according to the National Bureau of Statistics.

While there is evidence Chinese consumers are refraining from big ticket purchases like homes and autos amid a decelerating economy and trade war with the US, consumer confidence remains fairly solid overall. So far this year, consumer spending is responsible for over 75 percent of economic growth.

Foreign businesses are aware of this potential, with respondents to the AmCham survey stating that rising consumer spending is the top factor poised to benefit them in the next three to five years.

Businesses selling to the Chinese market enjoy a number of benefits by manufacturing domestically. In addition to being able to tap into China's vast manufacturing and sourcing network, the proximity to the end market allows products to reach the consumer rapidly and affordably.

Moreover, businesses can avoid China's high tariffs as well as retaliatory tariffs on US imports. Although China has been steadily cutting tariffs in recent years, the overall average tariff rate of 7.5 percent is still over twice as high as the OECD average.

In a similar vein, the gradual loosening of market access requirements means that foreign investors can operate wholly foreign-owned enterprises (WFOEs) in a growing number of areas, rather than be compelled to enter joint ventures (JVs). For instance, China will get rid of ownership limits in the auto industry by 2023.

Selling to the Chinese market is by no means a new idea. For many companies, China is already one of their biggest markets.

But improvements to the business environment, a continually wealthier consumer market, and international trade frictions are combining to make In China, For China a more attractive – if necessary – proposition.

The hidden implication behind In China, For China

What is left unsaid when a business proudly claims to be In China, For China is that they are moving elsewhere to produce exports for other markets.

Rapidly rising land and labor costs and a slowing economy are factors that foreign businesses have long factored into the equation when investing in China. The trade war with the US and other geopolitical risks have only hastened many firms' diversification away from China.

While in some ways In China, For China is the natural culmination of long-term macro trends, the speed at which companies are adapting to this strategy marks a sudden shift.

According to the Economist, China produces about 80 percent of the world's air conditioners, 70 percent of its mobile phones, and 60 percent of its shoes. Overall, China accounts for 35 percent of the world's manufacturing output.

Given there are so many products, small and large, that are completely tied up into China's supply chains, any idea that China will be cut off from producing for global markets is overstated.

This is not only true for product categories but individual companies as well. As recently as 2015, 100 percent of Taiwanese electronics company Acer's laptops were made in Chongqing, as were 90 percent of Japan's Toshiba laptops.

The size of the Chinese market and its sophisticated supply chains means that hardly any foreign business will fully exit. And for those that do recalibrate their supply chains, the process will be relatively lengthy and inevitably involve growing pains.

Nevertheless, the trend of companies pivoting to lower cost alternatives like India, Indonesia, and Vietnam for export-driven production is clear.

Indeed, many businesses have already done so. Google, for example, relocated much of the production of its US-bound motherboards to Taiwan and Malaysia in an effort to avoid tariffs. Similarly, the South Korean electronics giant Samsung recently closed its last smartphone factory in China; last year, it began operating the world's largest mobile phone manufacturing facility in India.

In the case of Samsung, smartphone production has been moved out of China completely. But what many companies are doing instead is adopting a China plus one strategy, where higher value manufacturing is done in China and lower value production done in a lower cost country.

Regardless of the exact strategy being used, many companies are relocating parts of their production to diversify their risks and tariff exposure. For some companies, In China, For China is merely giving a positive spin on a partial move away from the Chinese market.

What's next for investing in China?

The trade war has accelerated China's shift from being the factory of the world towards an increasingly domestic-oriented production base.

Indeed, the greatest economic cost for China rising from the trade war is not the tariffs themselves but the decline in business confidence among investors. Even for businesses minimally impacted by US-China tariffs, diversification is usually the prudent course of action to mitigate against future risks.

Yet, even if firms diversify their sourcing and production strategy, it does not necessarily mean they are divesting from China. The challenges facing China would have spelled crisis for most countries but the size and continued growth of its domestic consumer base means that it will remain an attractive destination for FDI. Further, given the sophistication of China's supply chain infrastructure, many companies have no choice but to maintain a significant presence in the country.

To be noted, although over half of the respondents to the AmCham survey stated that they plan on primarily pursuing an In China, For China strategy, close to half also said they were planning on increasing their investments in China – over the next year.

Such is the importance of the China market that the country demands a strategy and commitment beyond a "race to the bottom", that is, chasing the lowest costs possible. No matter how long the US-China trade war drags on, foreign companies will continue to regard China as an essential market, even if it's increasingly limited to In China, For China.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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