Decoupling or Not? Strategies for Foreign Companies in China

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Decoupling or Not? Strategies for Foreign Companies in China

🔥 I just finished reading a very good article about globalization strategies by Professors Stewart Black and Morrison.
Like any other investment, when companies are investing in China companies should fully understand the situation and circumstances, the pros and cons, consider the pitfalls, and understand the risks and rewards.
One fact is that the world has become more aware of its dependency on manufacturing in China due to the Covid-19 crisis. See: COVID-19 and its Butterfly Effect on Supply Chains and the World Economy. As a result, there currently is a widespread interest in decoupling manufacturing and supply chains and not only by former president Trump. On the other hand, most western companies are unwilling to pull out of China entirely, both for its unsurpassed manufacturing capabilities and for its huge market potential.

China itself has been following a long term (think 30 years) decoupling strategy with three key objectives:

1. Eliminating its dependence on foreign countries and corporations for critical technologies and products.
2. Facilitating the domestic dominance of indigenous firms.
3. Leveraging that dominance into global competitiveness.

Below chart makes it clear that China has been very successful with this long-term economic policy, declining its dependency on export of products and services.

China's export as a percentage of its GDP (1960-2019)
Source: Worldbank
According to Stewart Black and Morrison, as a consequence, foreign enterprises should build their strategy in China depending on their position in 2 axes:
A. UPSTREAM ACTIVITY FOCUS: The importance of the market opportunity in China.
B. DOWNSTREAM ACTIVITY FOCUS: The importance of China's production capabilities to the company strategy there.
This results in 4 quadrants, depending on the importance being High (H) or Low (L):

1. HH: Dual Players: Companies with revenue or a production alternatives should both decouple and strengthen their in-China Enterprises. Companies with no such alternatives should move what processes they can out of China.
2. HL: Upstream Players: Companies should create alternative production sites (known as the China + 1 strategy). Those with no alternatives should ensure that they have a winning value proposition.
3. LH: Market Players: B2C companies should pursue business as usual with local adaptation. B2B companies should pursue an "in China for China"-strategy to aggressively compete with in indigenous enterprises.
4. LL: Below-the-radar Players. Companies with small presence in China. Those in sectors targeted by the Chinese government (information technology, robotics and AI, aerospace, shipping, railways, energy, materials, medical equipment and medicines, agriculture, and power equipment) should hatch their bets in China. Those not in the targeted sectors should continue growing but be vigilant.

Source: J. Stewart Black and A.J. Morrison, "The Strategic Challenges of Decoupling: Navigating your company's future in China", HBR May-June 2021, pp. 49-54.