At a recent meeting, a senior executive at a major global brand asked me what other companies are doing about “China risk” these days. This morning, I came across a piece by Morgan O’Rourke on China risk in the new edition of Risk Management magazine (1). It seems, O’Rourke writes, that the events in Japan and Thailand in 2011 have spooked many companies when they think about a similar catastrophe taking place in China. As he notes:

But while the impact of the Japan earthquake was certainly profound, it reminded many companies that the supply chain effects of a similar incident in China could be even worse. According to a study by FM Global, 86% of companies surveyed say they are more reliant on China as part of their supply chain for their key product lines than they are on Japan (43%). And in the wake of the earthquake and tsunami, almost all companies (94%) are now concerned about natural disaster-related supply chain disruptions in China.

As a result, companies are starting to employ a variety of strategies to mitigate the supply chain risk of natural disasters in China. Among these solutions, 70% of companies plan to increase alternative sourcing, 65% are looking at increasing collaboration with suppliers on mitigating risk at their locations, and 61% are considering implementing a more robust risk management process.

The risk of a physical disruption in China is certainly a serious threat and one that, simply given its geographical size, should not surprise anyone when it arrives. However, in my visits to China and discussions with executives doing business there, the “China Risk” list goes way beyond a force majeure event of some kind. For example, I know of one European company that has become a victim of its own success in China. So well have they done manufacturing products in China in their own plants, that recently they have attracted the attention of a local, very well connected (and unwanted) buyer who has basically made them “an offer they cannot refuse” for all of their factories. In this case, the executive told me, a Chinese company has seen the value of the market this European entrant created and nurtured and has decided it is too good to leave to a non-Chinese player. Yet another example of the risk of success in China is a company that has done so well exporting into China that now 60% of its revenue comes from this market. Without much realizing it, the management team of this second firm have staked the company on the future growth in the Chinese middle class. Of course, everyone more or less expects that this strata of society will continue to grow but what if it does not? The company in question has borrowed to fund expansion of its product lines and export volumes in a giant bet on China’s upside. It’s the risk of China demand dropping, not  earthquakes or floods, that has this management team worried.

These risks and others like them are creating a four lane highway for Western companies in China, with traffic moving in both directions. In the first lane are those who are leaving China voluntarily. They think they see the handwriting on the wall and, often after a good run, have decided that it’s time to leave while they can set the terms of departure. The second lane, which will grow in the years to come, contains those leaving unwillingly, either through failure or success (as the case above points out). This group is either giving up or being told to take their money and leave town for their own good. On the other side of the highway, the third lane is those who are staying but are starting to hedge their bets, one way or another. The last lane is full of everyone who, unable to hedge their risk, find themselves with no choice but to keep on going and pray nothing goes wrong.

China risk management is more than worrying about a Fukushima on the mainland. Its about a bigger question: what lane are you on and does it take you back home or drive you deeper into the greatest economic bet of the last half-century.

(1) “Improving Supply Chain Resiliency in China and Beyond.” http://rmmag.com/MGTemplate.cfm?Section=RMMagazine&NavMenuID=128&template=/Magazine/DisplayMagazines.cfm&IssueID=362&AID=4481&Volume=59&ShowArticle=1

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Posted by Carlos Alvarenga

Carlos Alvarenga is the Executive Director of World 50 ThinkLabs and an Adjunct Professor at the University of Maryland's Smith School of Business.

One Comment

  1. Lokesh Chowdary February 17, 2012 at 05:29

    I think…one more interesting factor the companies to consider is Reverse JIT vs Alternate Sourcing. Does it make sense to have a extra buffer or resellers on the line of supply chain either at the middle or at the end (near customer) rather than going for alternate sourcing ?? It would be interesting to compare the costs and efforts. Alternate sourcing slightly defeats the logics of efficiency, core competency and strategic advantage. May be we have gone too ahead in Lean supply chains and JITs. The carry costs vs changing costs would be additional factor to be considered closely.

    Reply

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