Dealing With China Is Unavoidable. Mitigating Its Risks Should Be, Too.

Prolonged shortages of basic products such as N95 masks and semiconductor chips during the Covid-19 pandemic have stoked fear of being overly dependent on China. As a response, the Biden administration developed plans, with bipartisan support, to revitalize American manufacturing and secure critical supply chains for chips, pharmaceuticals, electric-vehicle batteries, and critical minerals.

Meanwhile, the tensions between the U.S. and China have intensified during Biden’s presidency. In addition to keeping former President Donald Trump’s tariffs for importing goods from China, the Biden administration is restricting Chinese companies from buying advanced chips and chip-making equipment, and prohibiting venture capital and private equity firms from making new investments in Chinese technologies that could be threatening to national security. 

These government actions mark a definitive shift in global supply chains that was previously called “decoupling,” but is now more commonly referred to as “derisking.” 

To “derisk,” many U.S. firms are shifting away from China to other friend-shoring countries such as India, Thailand, and Vietnam. Dell is considering shifting production away from China in favor of countries like Vietnam. A report by Bank of America found that Apple may shift 18% of its global iPhone production to India by 2025.

At the same time, many U.S. companies are increasing their sourcing volume from near-shoring countries such as Mexico and Canada to take advantage of the USMCA free-trade agreement. HP is expanding laptop production in Mexico. In 2022, Mattel announced its plan to expand its existing plant in the northern Mexican state of Nuevo Leon, surpassing other Mattel factories in China, Vietnam, and Malaysia.

Friend-shoring or near-shoring can improve supply chain resilience, but it is not risk-free. In politics, your friends today can become your foes tomorrow. 

U.S. firms must take proactive measures to mitigate the following risks.

First, the process of derisking from China could potentially trigger market risks. These risks may stem from retaliatory actions that could hinder the economic growth of the United States. For instance, in May, Beijing imposed a ban that prevented Chinese operators from purchasing chips from Micron Technology. Following this, The Wall Street Journal reported that China had prohibited officials at central government agencies from using iPhones. Apple shares fell 3.6% the next day.

More than half of Chinese consumers shun U.S. goods. Tesla continues to sell well, but the sales performance of many prominent U.S. brands has been declining in China since the trade war began in 2018. For example, GM’s market share in China has been falling in recent years, while Ford’s China sales have also been in decline. To mitigate market risks, U.S. firms need to develop plans to cultivate new markets such as India and Vietnam with growth potential beyond China.

Diversifying the supply base can also introduce various types of supply problems. Ensuring consistent product quality across different suppliers can be difficult, and coordinating with suppliers in different countries can negatively impact productivity. To facilitate efficient coordination, U.S. firms should encourage their suppliers to co-locate with their key factories. For example, Denmark’s Vestas, one of the world’s largest wind-turbine manufacturers, built two factories in southern India to derisk from China. To reduce coordination risks, a Vestas director said he expects 85% of its suppliers to eventually co-locate in India.

To facilitate efficient coordination, U.S. firms must establish supply chain visibility to manage operational risks. Today’s global supply chain operations are incredibly complex and opaque, with only 2% of companies in a 2021 McKinsey survey reporting visibility beyond their second-tier suppliers—suppliers that provide materials and parts to their direct suppliers. This lack of transparency can create incentives for suppliers to engage in questionable operations. For instance, South Korea’s SK Hynix stopped shipping chips to Huawei after the U.S. imposed an export control ban on advanced chips to China. However, a spokesperson for SK Hynix told CNN that the company is currently investigating its supply chain operations to determine how its chips ended up inside Huawei’s Mate 60 Pro phone.

Finally, sourcing from developing countries can lead to reputational risks. Law enforcement in these countries tends to be inconsistent, which may lead to suppliers violating worker safety laws or environmental regulations. For instance, many U.S. brands source their garments from Bangladesh. Unfortunately, due to lax enforcement, some contract manufacturers overlook building and worker safety issues. The collapse of Rana Plaza in Bangladesh in 2013, which resulted in the death of over 1,000 factory workers is a stark example. The public held some U.S. firms partially responsible for this tragedy. Walmart cut ties with a supplier who had operations in this facility without its knowledge. To avoid collateral damage caused by unethical suppliers, U.S. firms must conduct independent audits of these suppliers and ensure compliance by developing reward and penalty mechanisms. The principle of “trust but verify” is key.

Derisking from China appears to be unavoidable. Mitigating various risks associated with this process should be, too.

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