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Will Tariffs Drive Apparel Companies Out of China Once And For All?

Now that U.S. trade policy is determined tweet by tweet, brands and retailers are either finding contingency plans for their contingency plans, or mulling how to slowly back away from the chaos—which for many means scaling back on their China sourcing.

“If you look at last year…when [customers] heard about the first round of tariffs, they immediately moved to bring forward shipments and take fabric positions and that was a kind of short- to medium-term planning,” Newtimes Development CEO Paul Walsh said speaking at Sourcing Summit: Hong Kong last week. “Longer term, customers already have been making moves to divest—or I would say, not exit from China, but definitely reduce the risk.”

The slow roll out of China has been happening since before U.S. President Donald Trump was lobbing tariffs around, but the pace has quickened since he started upending trade relations with what’s still the world’s factory, regardless of how much those sourcing there may wish it weren’t.

“Ten years ago, China was 40 percent of U.S. apparel exports, today it’s 32 [percent], 33 [percent],” said Walsh, who heads the Hong Kong-based sourcing and supply chain management firm. “So, already in the last 10 years, production has slowly moved out of China and Southeast Asia. Several customers are better prepared today because they’re not so heavily in China as they used to be…so those plans in place are not necessarily new.”

What’s new, really, is the instability of today’s trade policy. All it took was a May 5 tweet from President Trump announcing an increase in tariffs on $200 billion worth of Chinese goods from 10 percent to 25 percent to get the rate change underway within days.

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“I think the suddenness of the tweet took some customers by surprise again, so we basically have to dust off a lot of scenario planning, relook at it and see how we can react,” Walsh said.

While most brands and retailers could stomach a 10 percent tariff, despite it going down bitterly, 25 percent could force many out of the running. If a company as big as Walmart could allude to raising prices for customers in line with the new tariffs, smaller companies—and the factories that produce for them—may not even make it that far.

“It’s a real issue and maybe some of you only deal with big companies, but for the SMEs outside of our industries, they’re just not having orders for some time,” said Sally Peng, member and Asia Pacific Practice leader for trade law firm Sandler, Travis & Rosenberg, speaking to an audience of sourcing and supply chain executives at the Summit. “It is really putting some people out of business. And not tomorrow, but immediately.”

For companies that own factories in China—or command the bulk of a factory’s capacity—Peng said it’s harder in China right now to close a factory than to open one in the event the new duties were too much to sustain.

“If you want to close the factory, there’s a lot of procedures you have to go through and a lot of money to pay just to close it. So what you’re likely to see is people are not closing the factory properly and will just bail,” Peng said. “There will be a lot of victims just because of the trade war.”

Some factories will be able to weather the storm, while others simply won’t. And in this case, size will likely matter.

“There’s two tiers of factories [in China], there’s the larger factories, the mega factories who’ve got the financial clout and the network to expand into multiple countries, which has been happening in the last several years. We see a lot of Chinese factories expanding into Vietnam, Cambodia, Bangladesh, Jordan,” Walsh explained. “And then you’ve got the second-tier factories that may not have the financial clout and they’re still based in China—how do they react?”

These factories are reacting, it turns out, by reinventing themselves and finding ways to embrace lean manufacturing.

“We’ve talked about moving from the cheap needle to the smart needle, and factories are relocating within China, whether its further north or more inland to cheaper provinces. I think it’s also technology. With investment in technology, factories can really use [it] to help reduce overhead costs,” Walsh said. “We are really encouraging factories to improve productivity in China, that there is still a future.”

The capacity question

For those companies still keen to escape China altogether—or at least as close to altogether as is possible—they’re turning largely to three countries: Bangladesh, India and Vietnam to spread out their risk. But with that, while these companies may not count tariffs among their risk factors, they’ll be facing issues of capacity.

“Vietnam has very close proximity to China for example, so the Chinese have also invested in mills in Vietnam. But Vietnam has become quite hot, and when it becomes too overheated, we need to think what’s beyond Vietnam,” Walsh said. “I think there’s still some capacity in Bangladesh and India, the price is very competitive, but also not without challenges.”

Whereas sourcing could have centered on price in years past, today it has to be about the ability to secure capacity, but also flexibility and lead times.

“Bangladesh doesn’t really have the flexibility that China has today so there’s no one right answer,” Walsh said. “Customers just really need to take a holistic view—price, flexibility, lead time—and I think that China…will play a very important role going forward.”

At the end of the day, divest, diversify—whatever it may be, companies will still be sourcing in China, 25 percent tariffs or not.

“You still cannot replace China,” Peng said. “There’s just so much infrastructure that’s already very mature in China and by sector as well.”

China for China

What companies need to consider now, beyond a China plus one or China plus four strategy, is a China for China strategy, Peng explained.

“Think about China, Indonesia, India as destinations as well. Before we all thought about the U.S. or Europe, but Japan is a destination,” Peng said. “We’re at a completely different game now. You should really think about China as a destination and build—if you haven’t done so already—a China for China strategy. That’s where all the automation will come in because that’s where it’s going to help you have flexibility.”