As China Costs Rise, Factories Relocate to Cambodia

Cam McGrath / Khmer Times No Comments Share:
A woman works at a Japanese-owned factory in the Phnom Penh Special Economic Zone (PPSEZ), on the outskirts of the capital. Photo: Reuters

PHNOM PENH (Khmer Times) – Foreign manufacturers eager to wean themselves off their dependence on China are rushing in to set up operations in Cambodia, leveraging the country’s low-cost labor and investor incentives to produce apparel, automobile electrical parts, cell phone components and even polished diamonds.

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Chan Sophal, an economist and spokesman of the Cambodian Economic Association, said rising labor and operational costs in Asia’s largest economy are bringing an influx of foreign-owned factories to Cambodia and creating fresh opportunities to diversify the Kingdom’s manufacturing sector. He said foreign companies with existing operations in China are relocating factories or establishing new plants in Cambodia, where labor and operational costs are “two to three times less” than in China.

“Many companies operating in China have chosen to set up factories in Cambodia because the labor costs are lower here and there are tax concessions for exporting products to Europe, Japan, etc.,” Mr. Sophal said.

Shifting Supply Chains

The past decade has seen seismic shifts in Asian manufacturing. In the early 2000s, Western manufacturers facing strong union movements and rising operational expenses on home soil relocated their factories en masse to China to benefit from lower costs. But driven by a rapidly growing middle class, China has become increasingly prosperous in recent years and factory wages have quadrupled since 2005.

Rising operational costs in Asia’s industrial heavyweight are forcing global retailers to search for new low-cost manufacturing destinations. Increasingly, they are finding their way to Asean nations – particularly Vietnam, Myanmar and Cambodia – which offer low-cost, youthful workforces for their production platforms.

While China’s one-child policy has led to a shrinking and aging workforce, by 2030, half of Asean’s 650-million-strong population will be less than 30 years old – and many prepared to work for significantly lower wages. Cambodia alone sees nearly 300,000 new entrants to the job market every year.

Andrew Géczy, CEO of International and Institutional Banking at ANZ, predicts that if current trends continue, Southeast Asia will take up China’s mantle of the “world’s factory” within a decade.

“During the next 10 years we expect Asean to replace China as the world’s manufacturing hub and we expect it to become the fifth largest economy in the world by the end of the decade,” he said in a recent posting on ANZ BlueNotes.

Investor Interest

Foreign investment in China has leveled off in recent years at around $125 billion after rising steadily since 1980. By comparison, the annual flow of inward foreign direct investment into Cambodia has nearly tripled since 2005, reaching $1.4 billion last year, according to UNCTAD figures.

“We continue to receive enquiries from… manufacturers interested in setting up operations in Cambodia,” said Bradley Gordon, managing partner of Gordon & Associates law firm. He said the investors include Japanese, Australian, Chinese and American firms in a variety of sectors, from garments to the food industry.

“Rising labor costs and regulatory challenges in China appear to be some of the main factors driving manufacturers to seek an alternative location,” said Mr. Gordon, “[while] Cambodia’s stability, economic zones and labor costs are all attracting interest.”

Hiroshi Uematsu, managing director of Phnom Penh Special Economic Zone (PPSEZ), said a number of foreign manufacturers with production lines in China have recently established factories in PPSEZ, Cambodia’s largest industrial park. But it would be a mistake to believe these companies are pulling out of China – most of these export-oriented factories were set up to supplement operations in China and hedge overall production costs.

“[Manufacturers] will not immediately close their factories in China,” Mr. Uematsu explained. “They will wait to see how the operation goes in Cambodia.”

Feeding the Giant

The investors are not just multinational corporations sourcing for Western retail markets; they also include numerous Chinese manufacturers producing for their home market. A free trade agreement (FTA) between Asean and China is fuelling a surge in Chinese trade with Cambodia. Bilateral trade rose by over 30 percent in 2013 and reached a high of $3.7 billion last year. China has also risen to become the largest single source of FDI in the Kingdom, accounting for about a quarter of all investment.

Chris Devonshire-Ellis, Partner at Dezan Shira & Associates, said the reasons that China-based companies are looking to invest in Cambodia are clear.

“They wish to take advantage of the lower operational costs in the country, use the ASEAN-China FTA as a duty free platform, and then re-export the goods back to China. While China is becoming expensive for manufacturers, the flip-side is an increase in wealth creation. China’s middle class is expected to reach 600 million by 2025, meaning that investing in production facilities with lower operational costs close to China makes a lot of commercial sense,” he wrote in his law firm’s publication, ASEAN Briefing.

Mr. Devonshire-Ellis said Cambodia’s close relationship and proximity to China make it a viable option for complimenting existing production lines.

“[Cambodia’s] lower operational costs may provide an opportunity to reduce overall China production costs by using a Cambodia facility to produce part of the existing or future required China manufacturing capacity for resale into the Chinese domestic market,” he said.

China Not Waning

Asean may be the next low-cost manufacturing destination, but China’s industrial stardom is hardly on the wane. It is just the type of manufacturing that will change. Factories are automating their production lines and switching from low-value garments and plastic toys to high-value aerospace parts and luxury goods.

Productivity in China is rising almost as fast as wages in many industries. It is one area where Cambodia lags far behind, say local factory operators.

“The labor costs in Cambodia are less than in China,” said Lim Pich, shipping manager at Top Fame Garments Ltd, a Chinese-owned apparel manufacturer in Phnom Penh’s Russey Keo district. “But the productivity and quality here is much lower than in China… where we also have a factory.”

Factory owners claim Cambodian workers sew 15 to 30 percent fewer pieces of apparel per day than their southern Chinese counterparts, and quality is often an issue. They also cite high electricity costs, inadequate logistics infrastructure and a restive labor pool as potential challenges for investors.

Wage Pressure

As more companies shift south, they are using up more of the local labor pool and pushing factory worker salaries up. Wages for industrial workers in Cambodia have increased as much as 65 percent in the last five years. 

While still low, industry heads have warned that continued wage hikes could push manufacturers to abandon operations in Cambodia in search of lower-cost emerging markets. So far, however, this does not appear to be happening.

“From time to time, we hear manufacturers say they are looking at other destinations such as Myanmar, but we have not had any clients relocate to date,” said Mr. Gordon.
 

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