The biggest direct impact of the trade war between China and the U.S. since July 2018 has been on two types of manufacturers: those primarily producing in China and selling to the U.S.; and those with manufacturing facilities in the U.S. but highly dependent on components sourced from China. The satellite manufacturers and players in upstream and downstream have also been indirectly affected.
After the wait-and-see period, which lasted six to twelve months, from the second half of 2018 to 2019, Taiwanese manufacturers have come to terms with the fact that the U.S.-China relationship will not be restored in the short term, and have gradually expanded production outside China with the so-called “China + N” strategy and are actively sourcing suppliers outside China.
Whilst these measures have no cost advantage over the tariffs, by adopting a ‘decentralized layout’, Taiwanese manufacturers seek to ‘reduce their reliance on production facilities in China and components manufactured in China.’
By 2019, the dispute between China and the U.S. had extended into a technology war. The U.S. government demanded that manufacturers that used more than 25% of U.S. technology, software, or components cannot sell their products to Huawei or other Chinese companies without first having obtained the approval of the U.S. government. In May 2020, the U.S. government then demanded that overseas semiconductor foundry companies who use U.S. made semiconductor equipment must not manufacture chips designed by Huawei (Hisilicon), unless approved by the U.S. government. At this juncture, the companies affected include all those that use technologies, equipment, or components from the U.S. and sell to China.
To mitigate risks, Taiwanese manufacturers have strived to diversify their sourcing and revenue streams. They are seeking to reduce their dependence on the Chinese market and have started to evaluate or use technologies or semiconductor equipment from outside the U.S. That said, the huge demand in China and the technological leadership of the U.S. mean the extent of diversification by Taiwanese companies remains limited.
The COVID-19 pandemic in 2020 has proven that a high degree of division of labor in the global supply chain is the most vulnerable to shocks. This is because each specific value chain activity tends to be concentrated on a small number of the most efficient suppliers. If any of these suppliers experience disruption, suspension or limitation to their production due to a black swan event, the whole supply chain may be paralyzed.
This is the reason why OEMs are moving toward decentralization, by adding participants or locations at each node of the supply chain. In response to requests from OEM customers and with a view to risk management, Taiwanese manufacturers will need to adopt a more flexible management model in order to support the efficient management of multiple sites and maintain existing effectiveness to avoid new entrants from snatching market share.
In the meantime, the incentives and supporting policies from different governments are also accelerating the pace of operational decentralization. For example, the Taiwanese government has been promoting “Three Major Programs for Investing in Taiwan” and the New Southbound Policy, to attract Taiwanese businesses to move their high-end production capacities back to Taiwan and deploy low-to-mid-end production capacities to South East Asia. The Japanese government is hoping to gradually diversify the sourcing of rare metals and plans to use subsidies to encourage Japanese companies to move production capacities from China back to Japan or other countries.
In addition, the pandemic significantly reduced the international trading of biotech and medical products. This created a sense of urgency for governments around the world, who realized it is necessary to boost local supply capabilities to respond to domestic emergencies and ensure national security.
Germany has announced measures to encourage German companies to manufacture medical protective equipment and products within its borders. This will help to ensure the long-term sustainability of its medical system.
In the past, the division of labor across the international supply chain was determined by market mechanisms. However, the black swan effects have pushed Taiwanese manufacturers to think about their risk control and geopolitical factors. The questions to be asked are whether they should reduce their dependence on production sites, components, and markets in China; whether they should purchase more technologies or semiconductor equipment from countries other than the U.S.; and whether they should increase the supply capacity of strategic sectors in Taiwan. Obviously, it is imperative that after these strategic adjustments are implemented, manufacturers can still maintain existing production efficiency and innovative momentum.
Against the backdrop previously mentioned, Taiwanese companies should speed up the introduction of digital solutions into the supply chain, to maintain or even diversify operational efficacy. For example, automation and artificial intelligence (AI) can reduce the labor requirements of production activities. This will help the migration of facilities to locations with higher wages (e.g. Taiwan) or without adequate skilled workers (e.g. South East Asia). The use of Big Data and AI technology can effectively connect supply chain members in different locations. This can assist manufacturers in the management of even more distributed production sites and suppliers for collaborative development.
Furthermore, the deployment of digital technology will improve production efficiency. This will assist the countries that were previously unable to produce strategic products domestically due to insufficient comparative advantage to construct a certain scale of local supply capacity.
The information, communication and machine tool industries in Taiwan are known for comprehensive clusters and international competitiveness. It is suggested that these sectors can leverage their advantage in hardware and reach out to startups in Taiwan or strategic partners overseas. By using the new facilities built with this wave of returning capital to showcase how Taiwanese companies can integrate software, AI algorithms, Big Data analytics (i.e. soft power) and export digital supply chain solutions. This will accelerate digital transformation and create new opportunities for the new generation of industries.