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Executive summary

ASEAN: A region on the rise

If the recent state of the global economy could be distilled into a single saying, it would be that when a door closes, a window opens ? and in Asia's case, that window looks towards the south. China, the longstanding world champion of growth, is now slowing down, Japan has slid into recession and South Korea's economy is also gradually decelerating.

But due to the collective strength of their southern neighbours, Asia is poised to once again be the engine of global GDP growth in 2015. The Association of Southeast Asian Nations (ASEAN) has become the new investment hub of the region, seeking to equal if not replace China as the region's manufacturing powerhouse. It is already the world’s fourth-largest exporting region and is poised to reap the benefits of a demographic dividend over the next two decades, thanks to rising youthful populations and increased consumption.

The gradual opening up of Myanmar, the steady growth of Vietnam and the development of Laos and Cambodia, all attractive, low-cost alternatives to China are fast emerging in a region with growing clout and significance as a manufacturing hub.

With China restructuring to move from a manufacturing- to service-based economy, there are opportunities for the smaller ASEAN nations to supply the growing demand for low-skilled production work, but the development gap between countries and the speed of the ASEAN Economic Community (AEC) integration ? in particular trade rules and regulations ? are growing concerns.

ASEAN’s favourable trends

Taken together, ASEAN’s 10 members ? Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam ? already comprise the world’s seventh-largest economy. Thanks to a rising youthful labour force and increased consumption, it is now also poised to reap the benefits of a demographic dividend ? a period in which the ratio of employable workers rises against the number of dependents.

ASEAN has the world’s third-largest population and is expected to reach 680 million people by 2020. Urbanisation continues unabated: an expected 52 percent of the region’s population is based in urban centres, and as more people enter the middle class, analysts predict that consumer expenditures will reach US$2.3 trillion by 2020.

With some 60 percent of the total population of ASEAN under the age of 35, multinationals are taking advantage of the region’s labour surplus, especially in light of China having spent its own dividend and now entering a period of demographic ageing.

Investment is currently at an all-time high, with foreign direct investment (FDI) inflows into the region’s five largest trading countries (the “ASEAN-5” ? Indonesia, Malaysia, the Philippines, Singapore and Thailand) totalling US$128.4 billion in 2013, according to Bank of America Merrill Lynch. In terms of both total foreign investment and year-on-year growth, ASEAN countries outperformed even China that year, and analysts believe that 2014's numbers will tell a similar story.

FDI in the region is mostly in manufacturing and services ? but manufacturing investment in particular has recently spiked ? rising from US$18 billion in 2012 to US$41 billion in 2013, according to a 2013-14 ASEAN Investment Report from the United Nation’s Conference on Trade and Development.

Enter the AEC

ASEAN currently accounts for about five percent of global manufacturing, with dominant shares in sub-sectors such as chemicals, food and beverage, metals and motor vehicles.

This year marks a critical step on its manufacturing journey with the launch of the AEC in December. With a stated aim of removing barriers to the movement of goods, services, capital and people throughout the region, the AEC is seen as an accelerator of manufacturing opportunities, especially among second-tier ASEAN nations, with companies looking to expand their manufacturing base.

“The reason ASEAN is going through the single-market production process is we need to have a production network within the region,” says Sanchita Basu Das, lead researcher for economic affairs in the ASEAN Studies Centre at the Institute of Southeast Asian Studies. “The aim of the AEC is to make these countries participate more effectively in the (manufacturing) supply chain network.”

In 2006, ASEAN was a regional base for 49 of the companies in the Forbes Global 2000. By 2013 it had 74, including 227 of the world’s companies with more than US$1 billion in revenues, or three percent of the world’s total

According to a recent report by the McKinsey Global Institute, if ASEAN implements the AEC’s integration strategy fully and is able to capture a larger share of global manufacturing, the region could gain US$280-US$625 billion in annual GDP by 2030.

“Over the next 10 to 15 years, we’ll see companies spread their manufacturing base across the region,” says Richard Owens, CEO of DHL Customer Solutions & Innovation. “Some smaller companies will become viable options for manufacturing as an alternative to the current main areas of China and Thailand, and perhaps Vietnam as well. What we have to remember is that very often the manufacturing process is done in stages throughout different areas ? components may be manufactured in one country, while assembly is done in another. These countries will be good places to start at the low end of the chain.”

According to global consulting firm Accenture, nearly 40 percent of ASEAN-based multinationals are currently looking to move their production base closer to the market, with 48 percent planning such a move in the next three years.

Rolls-Royce case study on manufacturing across the region

Rolls-Royce already has a firm foothold in Singapore, with operations and suppliers located in outlying ASEAN countries. Its facility in Vung Tau, Vietnam, employs 100 people and manufactures specialised winches for its marine business; a Thailand-based supplier produces and delivers parts for aero engines to both its UK and Singapore businesses, while there are suppliers also embedded into its operations at Changi Airport.

“There’s a tiered approach in a way, where Singapore can cater to the highest end and highest sophistication of activity in the aerospace industry, and is also a serious hub in manufacturing with regards to repair, servicing and overhaul,” says Jonathan Asherson, regional director, ASEAN & Pacific, Rolls-Royce, which manufactures aircraft and marine engines in Singapore and employs more than 2,000 people across two joint ventures.

As manufacturers look to offset production to ASEAN, countries such as Indonesia, Malaysia and Thailand will become viable options, Asherson adds. Here, manufacturers will look to integrate and “undertake a wider breadth of activities” while remaining close to their “hub” for logistics, cost and management efficiency reasons.

“The supply chain is driven to cluster for their own reasons in terms of cost reduction and logistics reduction ? but then you have to gauge the capability in places like Thailand, Malaysia and Indonesia, where you’d look for an alignment of work skills and especially work-skill qualifications,” he says.

Denso case study on optimising labour costs

In 2013, Japanese auto-components maker Denso set up operations in Cambodia as part of its efforts to enhance its production and supply framework in the ASEAN region. Denso already has operations in Singapore, Thailand, Indonesia, Malaysia, the Philippines and Vietnam. In Asia and Oceania, it employs more than 31,000 people with consolidated sales totalling US$7.6 billion for the fiscal year ending March 31, 2012.

The move into Cambodia is still in its infancy, but it is part of a bigger strategy for the region driven by rising labour costs in other parts of ASEAN.

“This is a small operation to look at labour workforce optimisation because labour costs are sky-rocketing in Thailand and Indonesia,” says Stefan Pun, manager, regional logistics and trade facilitation at Denso International Asia. “We’re looking at the second-string Mekong countries to do the more labour-intensive jobs that will allow us to free up our resources in Vietnam, Thailand and Indonesia.”

In its new Cambodia operation, Denso employs around 100 people doing mainly manual processes and supporting the bigger Thailand automotive market rather than focusing on individual production for Cambodia. Jobs include quality-assurance inspection and processes or minor reworking, which includes grinding and sanding for automotive components.

“We want to understand the labour setup and the industrial relationships here,” says Pun. “At the moment we don’t have time to set up big factories in the CLMV countries (Cambodia, Laos, Myanmar and Vietnam), just processing plants. This whole move is still really in its infancy; we’re trying to see whether it’s really feasible to set up a factory because access to a skilled workforce in these areas is a concern. After all, Cambodia is not really industrialised yet. So, we’re starting small.”

China’s refocus: A boon for CLMV ...

As China looks to restructure its economy, its rise up the export market value chain is seen as an opportunity for smaller ASEAN markets such as Cambodia, Laos, Myanmar and Vietnam. Average costs for factory labour are about US$7 a day in Vietnam and US$9 a day in Indonesia ? far lower than the US$28 per day in China.

Rising wages and an ageing population make low-cost production increasingly untenable in China, and while analysts see it remaining a leading producer, its influence at the low end of manufacturing is expected to wane.

“The economic transitions taking place in China offer ASEAN a window of opportunity to capture a greater share of global manufacturing opportunities,” says M.S.K Muralidhar, manufacturing industry leader, Deloitte Southeast Asia. “Many of the multinationals who are daunted by the complexity of operating in China are also scouting for alternative lower-cost bases. Capturing these opportunities is extremely critical to develop a competitive manufacturing sector.”

Given China’s focus to move to higher value-added manufacturing and the increasing labour costs that this incurs within the country and in other ASEAN markets, analysts foresee that some of the lower-end manufacturing work is likely to shift to Cambodia, Laos and Myanmar. These markets will act as subordinate manufacturing hubs to China to include the manufacturing of electrical, electronic and auto components, despite concerns over low productivity levels.

“There is likely to be a concentration of automotive, home-appliance and hard-disk-drive sectors in Thailand,” says Muralidhar. “There is potential for Cambodia, Laos and Myanmar to focus on some of the less complex auto components like wire harnesses and electronic components that go into final assembly of home appliances and hard-disk drives.”

... Or a double-edged sword?

Trade with China has contributed significantly to the economic development of the Southeast Asian countries it shares a border with ? that is, Laos, Myanmar and Vietnam ? and trade with each of them has been substantial. In 2010, for example, bilateral trade volumes with Laos reached US$1 billion, rising to US$1.73 billion in 2012.

The relationship between the CLMV countries and China will be complementary and collaborative, analysts say. China will continue to require more natural resources and electrical/electronic components from the region to supply its own growth.

In Myanmar, the new Thilawa Special Economic Zone, which is located on the outskirts of Yangon and is scheduled to open in the middle of 2015 will boost trade flows with China and establish a model for ASEAN countries. “China sees countries such as Vietnam, Cambodia and Myanmar as locations where they can extend their manufacturing,” says Owens.

But there is also likely to be increased competition between China and ASEAN, particularly in the automotive sector, as China consolidates its auto industry and evolves towards being a major exporter of automobiles and components. Most ASEAN nations deal independently with China, but experts believe that the region is strategically important as China looks to compete with regional economies.

“It is the individual country in ASEAN that pursues its relationship with China,” says Das. “I think China is aware of its own disadvantages and ASEAN’s advantages and will be using ASEAN as a way to lower its manufacturing costs, to remain competitive with Japan and Korea.”

A drive to succeed

There are institutional barriers to productivity in second-tier ASEAN countries. Das says the development gap between its richest and poorest countries is a matter of concern with human resources, efficiency of economic institutions, soft and hard infrastructure and the use of ICT (information and communications technology) in the production process is still way behind most developed countries.

“Participation in the supply chain has not been happening until now because even if the wage costs are low in these countries, productivity is also low,” says Das. “Once we can solve this development gap, then I think ASEAN can pursue its objective of a single market with more efficiency, and I can see how the production fragmentation of the supply chain can be built up within ASEAN.”

A bigger stumbling block is the AEC’s speed of integration. There are still multiple barriers to the harmonisation of trade laws and regulations in the 10-nation community, necessary to support the free flow of goods and enhance manufacturing output.

Although most of the larger ASEAN nations have eliminated tariffs on almost all goods that are produced in the region, Cambodia, Laos, Myanmar and Vietnam are lagging behind.

Foreign ownership is restricted in smaller ASEAN countries, too, and customs processes vary ? it can take between four and 26 days for goods to clear an ASEAN customs checkpoint. Some customs documentation is still printed in local languages only, which affects the efficiency and cost of moving goods in the region, while some countries don’t allow trucks and trailers to drive across borders.

“At the moment there is little harmonisation in terms of trading rules and laws and regulations, and these really do need to be addressed,” says Owens.

Over the next three to five years, many expect the smaller ASEAN nations to move up the manufacturing value chain as Vietnam has done. A small player in the global electronics-supply chain just a decade ago, Vietnam exported US$38 billion in devices and components last year, according to data from the International Trade Centre. It now ranks as the 12th-largest electronics exporter in the world.

“A lot of the future depends on whether the AEC comes together,” Owens adds. “There are still some question marks and a lot of hurdles to overcome to make this an efficient, functioning trading community ? but the intent is there, and the desire is there.”

Written by Rob O'Brien. Additional contribution by Melissa de Villiers. Edited by Andrew Cohen and Clement Quek. This article was first published on Singapore Business News.

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