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The China Plus One Model and the Competitive Advantages of Manufacturing in Vietnam

The China Plus One Model

China’s cheap land and labor, huge market, and preferential investment policies long served as the main driving force behind foreign investment in the country. However, China is gradually losing its cost advantage and competitiveness in comparison to other Asian countries. As a result, many companies in China are looking to diversify their operations by adding another location in Asia. This strategy is known as the ‘China plus one’ model.

Businesses adopt the China plus one model to reduce operating costs, diversify workforces and supply chains, as well as access new markets. Businesses that adopt the strategy become less vulnerable to shocks like supply chain disruption, currency fluctuations or tariff risks. Businesses can quickly scale up one country if market or operating conditions deteriorate in the other.

Vietnam: Your China Plus One?

The state of manufacturing in Vietnam today so closely parallels that of China ten or more years ago—when low-wage, low-tech, low-added value manufacturing acted as a magnet for FDI into the country—that many foreign investors with existing China operations are actively inquiring about the payoffs of moving to Vietnam. As China moves further up the value chain in manufacturing, Vietnam has been well-poised to pick up the slack. As a result, Vietnam’s manufacturing sector grew at a compound annual growth rate of more than 9 percent between 2005 and 2010 and today accounts for roughly a quarter of its GDP.

RELATED: Choosing a Manufacturing Location in Emerging Asia

Since Vietnam’s accession to the World Trade Organization in 2007, foreign investment into the country has exceeded investment into Indonesia, the Philippines, and Thailand combined. According to Deloitte’s Manufacturing Competitiveness Index, Vietnam is on track to jump eight ranks among global manufacturers over the next four years, to tenth overall. Growth in the industry accelerated in the lead up to 2015, with the ASEAN Economic Community still due to come into effect by the end of the year, transforming the ten-country bloc (Vietnam included) into a single market and production base.

On the whole, the manufacturing industry in Vietnam is distinguished by a high degree of fragmentation and polarization. As of 2009, there were more than 415,600 registered manufacturers in the country, with the majority small and micro enterprises serving the domestic market. These are contrasted with large, foreign-invested enterprises manufacturing almost exclusively for export, with little integration between the two. The backbone of manufacturing is composed of five industries—agribusiness, leather, wood processing and products, metal products, and apparel—which together account for 40 percent of commodity exports.

The Vietnamese government encourages manufacturing through special zones featuring lower corporate income tax rates and limited-duration tax exemptions. Foreign investors in Vietnam also benefit from favorable tax rates on corporate income (22 percent) and dividends (0 percent), with plans stated to lower the former to 20 percent by 2016. Wages are at the lower end of the spectrum across Asia’s manufacturing hubs, at nearly half those of China (and less than half when adjusted for mandatory social insurance contributions).

Infrastructure in Vietnam, while surpassing that of the Philippines and Thailand in terms of coverage, still has room for improvement. A lack of unifying standards between Vietnam’s private and public education systems has resulted in a shortage of skilled workers in the country (nearly 87 percent of the workforce is unskilled). Going forward, Vietnam faces challenges of curbing the role of state owned enterprises (SOEs) in the economy and avoiding the trap of low value-added manufacturing. Recent government reports have emphasized the development of technology, mechanics, information and communications technology, and pharmaceuticals.

These factors and more combine to make Vietnam the ideal manufacturing export hub for pursuing a China + 1 strategy.

Emerging Strategy can provide customized market intelligence to companies seeking to enter the manufacturing sector of various emerging markets. We can conduct multi-country projects for such companies, allowing them to better understand which location best suits their individual manufacturing needs. For more information on Emerging Strategy and our services, please contact us.

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