Asia's Tigers Hang Tough

Pressure from China is forcing Southeast Asian factories to shape up

Just a few years ago, Park Sung Chun thought China might be his undoing. The Korean entrepreneur runs a sneaker factory near Jakarta and had feared competition from low-cost rivals in China. Now, despite higher labor rates and lower productivity, Park says he can compete by squeezing suppliers, revamping his logistics, and reshuffling his product mix to focus on hiking and work boots, plus adventure gear for women. "I can't compete with China in low-end, mass-market sports shoes, so now we specialize," he says. Rather than aiming for sales in the U.S., Park has shifted his efforts to Europe and the Middle East, which are cheaper to reach from Indonesia.

Manufacturers across Southeast Asia tell similar stories. A few years back, factories from Cebu to Surabaya feared they might be crushed by China's export juggernaut, leaving the region dependent on sales of raw materials for survival. But today Southeast Asia's makers of car parts, electronics, clothing, and more have adapted to China's challenge by moving upscale, exploiting niches, and diversifying their target markets. They're also benefiting from a reluctance among manufacturers to focus too heavily on China alone. "No one wants everything in one basket," says Terry Weir, vice-president of Hana Microelectronics, a semiconductor company in Thailand. "We expect that Thailand, Singapore, Malaysia, and the Philippines will all have a place" in Asian manufacturing.

In fact, Southeast Asia's factories have been thriving lately. The region's manufactured exports hit $365 billion last year, double the level of a decade earlier. Over the same period, while China has boosted its share of world trade to 5.3% from 2.2%, Southeast Asia has managed to hold its share steady at 4.4%. "The fear of China has been driving competitive responses from Southeast Asia," says Cliff Tan, an economist for Citigroup (C ) in Singapore. "That means the companies in [Southeast Asia] are a whole lot more efficient than they were five years ago." For instance, the island of Penang -- Malaysia's premier electronics manufacturing zone -- lost 40,000 jobs in the past five years, even as electronics exports jumped by 40%.

Southeast Asian industrialists have also found steady sales in feeding the beast they once thought would destroy them. China last year bought $13 billion worth of goods from Malaysia -- more than 10% of Malaysia's exports, up from 2.5% eight years ago. More than 80% of that was manufactured goods such as Intel Corp. (INTC ) microprocessors, which are assembled in Penang and installed in PCs in China. Region-wide, exports to China represent some 12% of the total, more than double their level in 1997. "As China becomes the factory to the world and a prosperous market, we in Southeast Asia are becoming key suppliers to China," says Mari Pangestu, Indonesia's Trade Minister.

This has all happened despite strengthening currencies around the region. Since August the Singapore dollar has risen by 4.2% against the dollar, and the Thai baht has jumped by 7.2%. The Malaysian ringgit remains pegged to the dollar, but that's likely to change soon, and experts believe it will rise by 10% to 15%. Nonetheless, few manufacturers are complaining. Sure, stronger currencies make their exports pricier vis-à-vis goods from China (where the yuan remains tethered to the dollar), but they also make imports cheaper. And many factory owners in Southeast Asia are looking to buy equipment from abroad to upgrade their facilities to stay ahead of Chinese rivals, so they're likely to benefit from appreciating currencies. Stronger currencies "will allow the region to move up the ladder" in manufacturing, says DBS Bank economist Chua Hak Bin.

One of China's strengths is the web of component makers that it has spun out to serve manufacturers. Although Southeast Asia has long had its own networks of suppliers, they're now getting stronger in response to China's rise. Some 80% of the world's disk drives, for instance, are made in Southeast Asia, and the region has actually clawed back market share from China as more drives end up in consumer devices such as MP3 players and TiVo (TIVO )-style digital video recorders. A third of all DVRs are already made in Southeast Asia, as are many MP3 players, so it makes sense for hard-drive makers to stay in the region. Seksun Ltd. last year sold more than $70 million worth of components to hard-drive manufacturers from its plants in Malaysia, Singapore, and Thailand. Even though Seksun has factories in China to service customers there, "we are essentially a Southeast Asian manufacturer because this is where the world's hard-disk-drive cluster is," says CEO Felix Ong.

Each country in the region is finding niches where it can prosper. A third of the world's microprocessors are assembled in Penang, for instance. The plants are adjacent to the Penang airport, which has at least three cargo flights daily to the U.S. And while Singapore has had foundries (which make chips for other companies) for a decade, the number has been expanding lately, with four plants currently under construction at a total cost of some $6 billion. Thailand, meanwhile, has become a center for auto parts. The industry there has grown to some $9 billion a year, with 700 manufacturers churning out everything from axels to air-conditioners.

Big foreign manufacturers have also been key to Southeast Asia's resilience. Pharmaceutical giants including Pfizer, Novartis, and Glaxo SmithKline have invested a total of $700 million in Singapore over the past three years and have committed to spend another $1 billion by 2008. Advanced Micro Devices (AMD ), Dell (DELL ), and Intel have all expanded and upgraded their operations in Penang in recent years. And Singapore-based Flextronics International (FLEX ), the world's largest electronics manufacturing services company, now has 20,000 employees and 2.5 million square feet of manufacturing capacity in Malaysia -- 30% more space than three years ago. The company, which makes Sony Ericsson handsets, Hewlett-Packard (HPQ ) printers, Xerox (XRX ) copiers, and products for dozens of other companies, expects to expand in Malaysia even as it puts further expansion in China on hold. "Malaysia has a strategic geographical location, mature supply base, excellent infrastructure, a wealth of technical talent, and a stable currency, not to mention political stability," says Peter Tan, Asia-Pacific chief at Flextronics.

Many smaller manufacturers, meanwhile, have resisted the siren call of China. Koda, a Singapore-based furniture maker, has been growing by 25% annually for three years and last year sold $42 million worth of goods. Koda knew it had to do something to compete as China was emerging as the world's primary supplier of low-cost furniture. So it decided to transfer much of its production to Vietnam, where wages were lower than in China and where the government was offering tax incentives. But the company kept its design and development facilities in Malaysia and moved into higher-end furniture with more complex designs and better margins. Today, 60% of Koda's production is in Vietnam, 30% in Malaysia, and less than 10% in China. "We do all the design, development, and high-end work in Malaysia, mass manufacturing in Vietnam, and some assembly in China," says CEO James Koh.

Southeast Asia still isn't cheap. Workers in top-tier factories in Malaysia earn $1.50 per hour, about double the going rate at similar plants in China. The good news is that labor represents only about 4% to 8% of costs in electronics manufacturing -- so higher wage rates aren't all that important. And some manufacturers say skilled engineers are easier to come by in Southeast Asia than they are in China. "There are a lot of products that it makes more sense logistically to produce outside China, even though the labor cost might be more alluring [there]," says Flextronics' Tan.

Of course, Southeast Asia hasn't left its China problem completely behind. Mainland manufacturers continue to improve their skills and their productivity, and China offers an internal market that will always dwarf those of the Southeast Asian countries. But give the region's manufacturers credit. They have proved remarkably resilient in the face of the Chinese threat. The Tigers still have some spring in their step.

By Assif Shameen in Singapore, with Frederik Balfour in Bangkok

— With assistance by Frederik Balfour

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