It started in September of 2018 when the Trump Administration imposed 10% tariffs on $200 billion of China imports, including POP displays. By May of 2019, 10% became 25%, and the U.S.-China trade war was in full bloom. The magnitude of this economic shock prompted some of the largest U.S. retailers and manufacturers to reevaluate their supply chains. Some moved a portion of their production to Vietnam. Others set up shop in Mexico. Reshoring and Nearshoring became popular buzzwords. While the tariffs served as a wakeup call for many U.S. manufacturers who had become overly reliant on China manufacturing, the impact of the tariffs was not enough to justify a complete withdrawal from China. Rather, many companies, including POP display manufacturers, pursued a rebalancing and diversification strategy for their manufacturing and sourcing operations.
After more than 2 years of 25% tariffs, the POP display industry has largely adjusted to post-tariff reality. Most of these tariffs have been baked into industry pricing. The can has been kicked down the road, and what once was an unfathomable shock has become the new normal.
In early 2020, the world was greeted by COVID-19, an unwelcomed intruder who showed up unannounced. The trillions of dollars of economic damage, retail closures, and supply chain disruptions that ensued are well documented. As POP industry participants struggled to survive, few saw what was coming next: an unprecedented increase in ocean freight rates. The ocean freight on a container from China to Los Angeles was about $3,000 in 2019. Now it costs more than $20,000 with projections of $25,000 to $30,000 or more by the end of the year and into 2022. On top of the 7-fold increase in ocean freight rates, there are recently announced additional port congestion surcharges of more than $1100 on containers coming from China. These surcharges are scheduled to escalate to almost $3400 for 40’HQ containers arriving to the U.S. West Coast starting September 15th.
So now what? What does it mean for Chinese POP display manufacturers and for U.S. display companies that rely on Chinese factories to serve their customers? The answer is it’s complicated. Let’s take a look at the key forces at work, some of which we have already mentioned. Then let’s unpack the implications and try to reach a conclusion.
Forces at Work
There are a number of key forces at work that will continue to put pressure on Chinese POP display manufacturers:
● Trade War/Tariffs– U.S.-China trade tensions show no signs of letting up, and the current 25% tariffs create a significant economic disadvantage for Chinese POP display manufacturers.
● Ocean Freight– As discussed above, the astronomical increases in ocean freight fundamentally change import economics. Given the high barriers to entry related to the capital-intensive nature of the ocean freight business and the disincentive to put more vessels in service on the part of industry participants who are now making huge profits and have a clear understanding of the inelasticity of demand (i.e., they can raise prices without impacting demand).
● Covid– Covid will continue to impact Chinese POP manufacturers both from a demand perspective as restrictions continue to reduce the demand for displays as well as from a supply disruption standpoint, making it more difficult for them to get raw materials and deliver on time. Covid will continue to wreak havoc on global supply chains for at least several years as we are unlikely to achieve herd immunity in the U.S., in China, or elsewhere in the world. None of the 4 requirements to achieve herd immunity are likely to be met: (1) An effective vaccine that offers durable lifetime immunity, (2) A minimum of 70%-80% of the population vaccinated and upwards of 90% vaccinated based on the new variants, (3) A vaccine that confers sterilized immunity (i.e., blocks transmission of the virus), (4) The virus cannot have an animal reservoir (animals that can act as a host for the virus).
● Material cost increases– Raw material costs have increased significantly in China as they have globally, resulting in one less avenue for Chinese factories to offset rapid cost increases in other areas. For example, Chinese steel prices have increased 43% over the past year.
● Labor Cost Increases– Wage inflation in China has outpaced other alternative manufacturing markets. For example, between 2019 and 2020 the average hourly manufacturing wage in China increased from $5.78 to $6.50, or 12.5%, compared to Mexico whose average hourly manufacturing wage increased from $4.66 to $4.82, or 3.4%, during the same period. Mexico’s average hourly manufacturing wage is now more than 25% below China’s.
● Reshoring and Nearshoring Movement– As discussed, ever since the start of the trade war, Reshoring and Nearshoring have been gaining momentum. When supply chain executives add up the cost of tariffs and the increasing rate of ocean freight while watching China’s labor cost advantage evaporate, it provides convincing evidence to make Reshoring and Nearshoring a strategic imperative for their companies.
● Market Psychology/Buyer Fatigue– Although it is harder to quantify, buyers are beginning to experience overseas buying fatigue. They understand the value of time to market and the importance of reliability within their supply chain. With constant shipping delays and unpredictable congestion at the ports, many buyers are experiencing import fatigue, and the market psychology is beginning to favor taking back control and reducing timing risk that may jeopardize key retail program launches.
● Climate Change– With increasing worldwide visibility on climate change and major initiatives on the part of governments and companies in Europe and the U.S., there is growing pressure to combat global warming by manufacturing and sourcing closer to the end user. The momentum behind Reshoring and Nearshoring is being driven in part by climate change concerns. It is estimated that a single large cargo vessel emits as much pollution as 50 million cars, and 15 of the largest cargo vessels emit as much pollution as all of the cars in the world. If the shipping industry were a country, it would rank between Germany and Japan as the 6th largest contributor of CO2 emissions.
Implications
Given these forces at work, what are the implications? We see the following:
● Industry Consolidation– The cumulative impact of these key forces at work will cause continued industry disruption resulting in accelerated POP industry consolidation. Small factories in China are unlikely to survive. Similarly, small and undercapitalized manufacturers, brands, and retailers will exit, hastening industry consolidation.
● Lower Profitability– Surviving China POP display manufacturers will experience an extended period of lower profitability. As demand for displays decreases, there will be greater price competition among Chinese factories which will put pressure on margins and profitability.
● More Reshoring/Nearshoring– U.S. companies will continue Reshoring and Nearshoring efforts but will continue to maintain China manufacturing as a meaningful part of their manufacturing mix.
● Increased Automation– Surviving Chinese manufacturers will increasingly invest in automation to counteract continued wage inflation.
● Uneven Impact Across Material Categories– The negative impact of the recent economic shocks will not be felt evenly across manufacturing segments. For example, it will have a bigger negative impact on Chinese factories that manufacture wood displays because the incremental ocean freight costs will further disadvantage these factories relative to U.S. manufacturers who can source wood competitively in North America. Similarly, acrylic manufacturers in China will see their advantage erode as a result of increased ocean freight since most acrylic displays do not knock-down. Chinese metal display manufacturers are probably the best positioned since China produces 51% of the world’s steel, giving them a raw material cost advantage. In addition, most metal displays can be made knock-down which helps mitigate the freight cost increases.
● Ecommerce Boost– The increased cost of displays and overall inflationary environment will likely provide a boost to eCommerce businesses as companies reach a spending threshold for instore merchandising and instead opt to steer greater investment to online distribution.
● Disintermediation of Middle Men– With rapidly rising costs, brands and retailers will be looking to streamline procurement, thereby posing an increased threat to middle men. The new normal will favor those who own the means of production and add the greatest value rather than companies who businesses are built on outsourcing.
Overall Conclusion
Our overall conclusion is that the road ahead for Chinese POP display factories is likely to be bumpy. Good factories will survive. Smaller factories who don’t achieve excellence in a specialized niche are likely to fail.
We would never bet against Chinese manufacturers. China has decades of invaluable manufacturing experience and a supply chain that is second to none. Not only do they have raw material cost advantages, but their factories have very high rates of productivity. These high rates of productivity are more than enough to offset a labor cost disadvantage whereby their labor rates might be double those of another country. Chinese people are extremely hardworking, resilient, resourceful, and highly ambitious. While the immediate future may require Chinese POP display factories to navigate the turbulent waters carefully, we think it is premature to be making funeral arrangements.