NEWS & EVENTS

The myth of manufacturing costs in Viet Nam

19/03/2020
You are looking for a brand new country to move your business into. You doing some google and find out a ton of articles related to how cheap and cost-saving moving your business to Vietnam. Is it actually true?

1st Manufacturing day (2)

VIETNAM OUTSOURCING PRESENTS:

THE MYTH OF MANUFACTURING COST IN VIETNAM

BY DANIEL PHAM - VNO DIRECTOR

Potential

In recent years, Vietnam is expected or considered by some as the 2nd Factory of the world, or the next Manufacturing Hub of the world after China; there are many driving factors behind this:

 

The labor cost in Vietnam is still highly attractive to many investors, the so-called “golden population” structure is perfect for the development of manufacturing industries.

More than 70% of over 90-million population are in working age, with almost balance male and female ratio and a healthy birth rate.

(source: https://www.gso.gov.vn/default_en.aspx?tabid=774)

1

 

Particularly, since the 1990s, many manufacturing giants have selected Vietnam as the destination for their factories. The existence of such international manufacturers, as well as the improvement in vocational schools across the country, give Vietnam the most promising technical workforce (engineers and technicians) compared to other neighbor developing countries – a fact agreed by many industrial experts and researchers.

 

The Vietnam government is one of the most active one in negotiation and implementation of Free Trade Agreement (FTA). There are 16 FTA in total being implemented at different stages.

(source: https://accessvietnam.vn/2018/08/vietnam-involved-in-16-free-trade-agreements/)

2015 is a landmark year when Vietnam signed four FTAs ​​with the EU, South Korea, EEC and TPP. By the end of 2016, Vietnam has signed, implemented and are negotiating a total of 16 FTAs; This is a very impressive number for a developing Asian nation. Out of these 16 FTAs, 10 FTAs ​​were implemented (six of which were implemented as ASEAN members, the other four FTAs ​​with Chile, Japan, Korea and EEC); Two FTAs ​​have concluded negotiations: TPP and the Free Trade Agreement between Vietnam and the EU (EVFTA); Four FTAs ​​being negotiated are the Comprehensive Economic Partnership Agreement (RCEP), the ASEAN-Hong Kong FTA, the FTA with Israel and the EFTA. Up to 2017, many foreign investors have plans to invest in Vietnam with a total registered FDI of $ 307.86 billion with 23,737 projects. 59 percent of the projects is in the field of processing and manufacturing.

 

Great efforts have been put in attracting foreign direct investment (FDI) as more and more modern industrial zones (with attractive tax incentive packages) were built. The government is also continuously improving the country administrative and logistic infrastructure.

 

Above all, the US-China trade war has really shaken up the global supply chain. Vietnam, as a result, is now considered as the most promising alternative. By right this should be the opportunity for Vietnamese manufacturers to bloom and capture the world market... but is that really what’s happening?

 

The stumbling blocks

In fact, the most developed manufacturing industries in Vietnam include: Apparels, Shoes, Wood & Joineries. These are all old industries, which are highly labor-intensive, with less added value and have been in Vietnam since the 1990s.

 

Electronic and household appliances is another blooming industry. However, most of the major players are Multinational company (MNC), while the percentage of localization and added value for local manufacturers are low. For example, company like Canon has been in Vietnam since 2012, but until now only has 20 local suppliers (who mostly do plastic part and packaging) out of their total of 175. Most of the important components are either imported or made by their other suppliers – including the Japanese, Taiwan, China FDI manufacturers in Vietnam. Why is this the case?

 

Actually, the obstruction in developing supporting industry/manufacturing industry in Vietnam has been there for a long time. Those are very broad, complex, high entry barrier industries with no shortcuts in development. Materials and industry experts are not available locally. The procedure and requirement to approve a new supplier often have to be very stringent - normally it takes 6-9months to complete from auditing, quotation, first article submission, to the first Purchase order. For automotive industry, this process can take 2-3 years.

 

Not every Vietnamese manufacturer is ready to capture the opportunities that arose in this global supply chain disruption.

 

Manufacturing hubs of the world can’t be formed overnight

 

It will be unrealistic to think that, one need only to fly to Viet Nam, visit some factories and orders can be placed. As mentioned above, the global supply chain disruption is supposed to be the opportunity for the Viet Nam local factories to shine. But in reality, it is more obvious than ever that Viet Nam (and maybe also the other neighbour developing countries) is not ready to take place as the second factory of the world. 

 

- Said mr Chris Mooney, Director of Chinaoutsourcing.com – an UK company specialized in metal parts outsourcing, which has been operating in China since 2002. China have the population 10 times bigger than that of Viet Nam, and their manufacturing industries have had 15-20 years ahead of Viet Nam. Almost everything you need for your production is available.

 

Moreover, the greatest advantages that Viet Nam possesses at the moment are merely temporary. The sudden change of the global supply chain and the increasingly establishment of FDI factories have lead to an early shortage of technical workforce. Worker salary (not the minimum wages) has been increasing faster than what happened in China. The FTAs are double-edged sword - beside the immediate advantage in export, it also creates great challenges for the local factories to compete on their own home ground.

 

There will be no immediate solution to move your supply chain to Viet Nam. After all, the manufacturing hub of the world can’t be formed over night.

The myth of manufacturing costs in Viet Nam

Besides the easy-to-recognize macro economy factors, there are many other reasons to explain why manufacturing costs in Viet Nam (and also other developing countries) are not as cheap as China’s.

Most American/Europian companies, when they first come to Viet Nam, find this difficult to understand. Afterall, the average labour cost in Viet Nam is half that in China; but, the quotations they get from Viet Nam manufacturers are often 1.5 – 2 times higher than their China’s equivalent. This, in turn, caught them absolutely off-guard.

Most recently, an American company send us an inquiry about Hydraulic Torque Wrench – Said Mr Daniel Pham, Director of VNoutsourcing.com (VNO), the Vietnam local office of Chinaoutsourcing.com. In Viet Nam, there are no company that specialize in this product, which means we will need to find factories with suitable machines, facilities and set up a new production line for it. The initial combined quotation is almost twice as expensive as that of China. It will take some time for VNO to set up and optimize to meet the targeted pricing of such customers.

It was also the wave of supply chain shifts driven by the US-China trade war caused the suppy and demand imbalance in Vietnam. Many Vietnamese manufacturers mistakenly believe that this opportunity will last forever and do not feel interested in providing good quality products at a lower cost than what they normally do. They do not think that for manufacturing industries with high technical barriers and complex management processes, being able to take part in the international customers supply chain in the long run will bring much greater benefits compared to the short-term benefit of a couple of high price orders.

Another subjective reason for the surprisingly high price of Viet Nam support industry manufacturers is the mindset of doing business based on relationship. This is rather difficult to get scientific statistic to illustrate this statement, but mostly base on take away from face-to-face meeting – Said mr Daniel Pham, Director of VNoutsourcing.com: “In my database there are about 2000 manufacturers in Viet Nam, which I myself visited about 300 of them. Manufacturers that are originated as a state-owned enterprise (SOE) usally have their “traditional” orders. This make the commercial orders not vital to their business. They don’t have enough pressure to provide the best quality product at competitive pricing. The studying of technical drawings, generating quotation, making sample, don’t get enough attention and focus as they should.”

It sounds hard to believe, but this kind of mind-set is also common in many private enterprises that have traditional orders with large FDIs. Such manufacturers often have good existing business results and strong production capacity. Over many years of optimizing production process for their traditional product, with timely information from the advantage of “good relationship”, the profit on each of their orders is much more attractive than the new inquiries that they need to compete with China. They are not overly keen on the new opportunities from the current wave of supply chain shifts. From a business point of view, for manufacturers that are successful and have a stable source of orders, doing so is not necessarily wrong. It is entirely up to them to decide where they will allocate their resources and time. However, many smaller private factories, when trying to develop their businesses, often try to mimic the bigger and more successful companies using the same mind-set. Although the market for the FDIs in the country is very large and is definitely a great playground for domestic factories to develop their capabilities; however, if they think it is the only available market, such companies will not be ready to take advantage of the opportunities brought by this wave of supply chain shifts.

On the other hand, it does not mean that just by changing the sales mindset, Viet Nam factories can immediately provide more competitive production pricing than China. Chinese businesses have much more accurate pricing experience than most Vietnamese manufacturing enterprises. The main formula for manufacturing pricing in Vietnam is: (direct cost) + (indirect cost) + (expected profit) = Price.

While the direct variable costs on finished products such as materials, labor, machine hours ... can be estimated quite accurately and easily (although it can be further optimized). It is difficult to dissect indirect costs (factories, energy, indirect labor, sales costs, customer care, defect rate, shipping, etc.) and accurately distributed on individual product. Many Vietnamese businesses determine whether their pricing are correct based on the quarter/annual profit and loss balance sheet (P&L).
And to be safe, they calculated with a large safety margin. The market diven pricing method - based on competitors' prices, and prices that customers are willing to pay are less oftenly applied. Therefore, many Viet Nam local manufacturing companies are not able to assess their competitiveness in the global supply chain.

How to overcome the differences?

So how could Viet Nam Manufacturers overcome these stumbling blocks and get ready for more opportunities given by the global supply chain shift? We think the fastest way is to open up and learn from the Western customers. Difficult technical requirements and quality control of customers are the problems, which if solved will improve the competitiveness of domestic factories greatly – said Mr. Chris Mooney. Beside, as previously mentioned, there are many similarities between Viet Nam and China - Vietnamese factories can learn from their neighbor about the most efficient way to organize production, gradually apply automation and advanced management method to optimize their production. Particularly, they can learn about the competitiveness of China price quotes in order to better position themselves into the global supply chains.

The actual job of moving production to Viet Nam is a hard and time-consuming job, said Mr Daniel Pham. We VNO are fortunate to collaborate with factory owners who have a clear awareness, willing and ambitious to take advantage of this transition wave. For example, we are working on a first article submission of several precision machined copper products with a factory in Dong Anh province. Right from the beginning, the factory director bought all necessary materials, measuring equipments according to the product requirement. Together we found some materials and tools are not available in Vietnam, so VNO transfered such items from our China office to the factory in order to speed up the sample-making process.

Our chief engineers and experts from China also came to the site, collaborating with the factory to help develop the process. Yet, it still took us 7 months to develop and undergo 3 sample submissions to get the samples approved.

For this product line alone, we are ordering about $3 millions annually from China. We are targeting to move $500k worth of product to Viet Nam in the first year. Our first and foremost priority is to ensure all technical and quality requirements are met and maintained. 

In conclusion

The chicken-or-egg issue is always a stalemate: Good production capacity (correct price, correct quality, correct delivery) ⇒ Many orders (bigger market) ⇒ Opportunity to learn, optimize production, more available market, better personnel ... ⇒ Better capacity ⇒ More orders ... (and repeat)
 

Blue and Mint Green Cycle Diagram

So good production capacity and big market, which one need to come first? In the case of today's manufacturing supply chain, it is a rare opportunity for Viet Nam manufacturing companies.

“The interest of the western customers in Vietnam is real and enormous. It is clear that Vietnamese manufacturing companies need to take initiative, constantly imrprove their production capacity and try to position themselves in the global supply chain. By doing so, the individual contribution of each factory will increase the general competitiveness and technical level of Viet Nam manufacturing industry. VNO is willing to work along side with the local manufacturers to grow and improve, get ourselves ready to seize international opportunities. This is part of our company’s mission.” – said Mr Daniel Pham.
 

Add a subheading

For the Western companies, they can easily find that new factories and trading companies in Viet Nam sprouting up like mushroom. However, not all of them have the adequate experience, expertise and knowledge to set up production professionally to ensure quality and delivery.


 

Older articles

Swivel Connector - A case study for Brass (Copper) Product

Swivel Connector - A case study for Brass (Copper) Product

Our customer is a market leader in surface treatment technology. Most of their...

Vietnam Outsourcing Pte Ltd at Manufacturing Match Making 2020

Vietnam Outsourcing Pte Ltd at Manufacturing Match Making 2020

The Covid-19 epidemic is still complicated, unpredictable and has a negative...

Manufacturing Match Making Event 2020

Manufacturing Match Making Event 2020

On July 23, in Hanoi, the Vietnam Association of Supporting Industries (VASI)...

The strength of Vietnamese SMEs is human resources

The strength of Vietnamese SMEs is human resources

On July 24 in Hanoi, Mr. Daniel Pham - Operational Director of Vietnam...

Sign up to download the profile

Complete your information in the form below

You did not use the site, Click here to remain logged. Timeout: 60 second