China: The Dragon's Effect on Southeast Asia

Research Brief China: The Dragon's Effect on Southeast Asia Abstract: The rise of China as a manufacturing giant is claiming some victims, particularly among Southeast Asian markets, which are scrambling to reassess their economic relationships with the emerging giant. By Philip Koh Recommendations Southeast Asian companies should seek to ally with, or acquire, local Chinese companies, and they should ensure that these local companies have strong market positions and extensive distribution networks in the Chinese electronic market. With Southeast Asia's strategic location and extensive linkages, enterprises in Southeast Asia should step up their drive to attract more high-tech, high-growth Chinese companies that can use Southeast Asia as their launching pad to regional and global markets. Companies should take advantage of China's low labor costs by outsourcing manufacturing there. Publication Date:16 June 2003

2 China: The Dragon's Effect on Southeast Asia Introduction The China Migration China's entry to the World Trade Organization (WTO) has undoubtedly altered the dynamics of this populous country, both socially and financially. It has substantially changed the competitive outlook and prospects of numerous industrial activities in the Asia/Pacific region and attracted foreign direct investment (FDI) to the region. China is expected to experience outstanding growth following its entry into the WTO, with a gross domestic product (GDP) forecast of from 7 percent to 7.5 percent for 2003. By contrast, Southeast Asia's GDP for 2003 is estimated to be from 3.5 percent to 4.0 percent. Southeast Asia organizations face a stiff challenge from the rise of the region's "Super Dragon." Canny Southeast Asian corporations, rather than cowering in China's shadow, will looking for ways to leverage opportunity from a market poised to become the powerhouse of global spending. With an impressive GDP forecast and tariff rates coming down during the next four years, mainland China is becoming increasingly attractive as an engine of growth for many industries, including the retail and consumer industries. Gartner Dataquest forecasts China's electronics equipment production revenue to increase from $125 billion in 2002 to $200 billion in 2007, at a compound annual growth rate (CAGR) of 9.9 percent. China's share of Asia/Pacific electronic equipment production is expected to grow from 38 percent in 2002 to nearly 42 percent in 2007, as shown in Figure 1. China's share of global electronics equipment production is also expected to grow from 11 percent in 2002 to 13 percent in 2007, as illustrated in Figure 2. China is emerging as an important player on the global and Asia/Pacific economic scene. 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 16 June 2003

3 Figure 1 China's Share of Asia/Pacific Electronic Equipment Production, 2002 and 2007 2002 2007 Rest of Asia/Pacific (12%) Singapore (6%) China (38%) Rest of Asia/Pacific (10%) Singapore (6%) China (42%) Malaysia (11%) Malaysia (10%) Taiwan (14%) Taiwan (12%) Total = $326.5 Billion South Korea (19%) South Korea (20%) Total = $477.3 Billion 115456-00-01 Source: Gartner Dataquest (June 2003) Figure 2 China's Share of Worldwide Electronic Equipment Production, 2002 and 2007 Others (1%) Communications (2%) Data Processing (4%) Consumer (4%) 2002 2007 Others (1%) Communications (3%) Consumer (4%) Data Processing (5%) China: $125 Billion Worldwide (89%) China: $200 Billion Worldwide (87%) 115456-00-02 Source: Gartner Dataquest (June 2003) 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 16 June 2003

4 China: The Dragon's Effect on Southeast Asia China's growth in electronics production will fuel demand for semiconductor consumption in the country. Semiconductor consumption market is expected to double by 2007, reaching $51.7 billion, up from $23.2 billion in 2002, with a CAGR of 17.4 percent, as shown in Table 1. The strong demand for semiconductor devices has enabled many chipmakers to achieve significant positive growth in 2002. Gartner Dataquest believes the positive trend will continue during the next five years. Table 1 China: Semiconductor Market Forecast (Billions of Dollars) 2002 2003 2004 2005 2006 2007 CAGR (%) 2002-2007 Total Semiconductor 23.2 27.4 36.6 46.7 47.2 51.7 17.4 Change (%) 34.2 18.1 33.8 27.6 1.0 9.5 NA General Purpose 13.7 15.9 21.7 28.2 27.9 30.3 17.2 Memory 3.7 4.6 7.0 10.4 8.8 9.9 21.9 Micro 3.7 4.0 4.9 6.0 6.5 6.6 12.1 Logic 1.6 2.0 3.0 3.8 3.9 4.4 22.6 Analog 1.6 1.9 2.6 3.1 3.6 4.0 20.7 Discrete 1.8 1.8 2.1 2.4 2.5 2.5 7.0 Opto 1.3 1.6 2.1 2.5 2.6 2.9 16.7 Application-Specific 9.5 11.5 15.0 18.6 19.3 21.3 17.6 ASIC 2.7 3.2 4.0 4.9 5.2 5.8 16.3 ASSP 6.8 8.3 11.0 13.7 14.1 15.5 18.1 NA = Not applicable. ASIC = Application-specific integrated circuit. ASSP = Application-specific standard product. Note : Hong Kong semiconductor consumption market is categorized under China. Source: Gartner Dataquest (June 2003) Gartner Dataquest Perspective Will China Be Both Competitor and Partner? The two main driving factors to China's competitiveness are costs and the market. The rise of China has motivated Southeast Asian companies to look into these important elements. Threats to Southeast Asia Threats to Southeast Asian enterprises include the following: China's significantly lower labor costs will offer the potential for China's exported manufactured products to undercut its Southeast Asia neighbors on cost. China's unassailably large domestic market will prove so tempting that it will attract all the FDI and stymie other Southeast Asian markets opportunities. With much focus and attention on developing its electronics industry, China's many incentives attract investors from other Southeast Asia markets. 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 16 June 2003

China's unwillingness to depreciate the Chinese renminbi causes problems for Southeast Asia exports. The rise of China as a manufacturing giant is claiming some victims. Many Southeast Asian nations are struggling to keep up with China on the cost front and are unable to match its vast labor pool and economies of scale. Lower-cost China is taking away Southeast Asia's low-value-added production. Several Southeast Asia markets except for Singapore, which relies on importing talent are unable to graduate to higher-value-added services, because they lack sufficient skilled labor. The combined percentage of Singapore, Malaysia and the Rest of Asia/Pacific, where electronics equipment production revenue comes mainly from market such as Thailand, Philippines and Indonesia, is expected to drop to about 26 percent in 2007, from 29 percent in 2002. These markets are scrambling to rearrange their economic relationships with China and must create economic scales for themselves. To increase Southeast Asia's competitive edge as a production base for multinationals, as early as in 1992, the Association of South East Asian Nations heads of government had already formally established their own Asean Free-Trade Area (AFTA) through the elimination of intraregional tariffs and nontariff barriers. The larger market enables investors to enjoy economies of scale in production. The recent Free Trade Agreement (FTA) between Singapore and the United States will also result in renewed business interest in the Indonesian islands of Batam and Bintan. Low land/labor costs and their excellent location, less than an hour's ferry time from Singapore, are two key elements for consideration of new investments. Overseas businesses can save costs by manufacturing some goods on the islands, while still enjoying tariff reductions under the FTA. In addition, Singapore and the United States are opening up a planned FTA to other Southeast Asian countries in a bid to boost trade and investment and promote reforms and economic integration in the region. The inclusion of more countries under the FTA with the United States will create an opportunity for U.S. investors to come to Indonesia, Thailand or Malaysia and to operate within a much larger marketplace. This initiative will make it easier for companies to locate production facilities in different Southeast Asian countries to exploit their competitive advantages. Opportunities for Southeast Asia Opportunities for Southeast Asian enterprises include the following: When China grows, it will provide a larger market for imports, particularly from Southeast Asia and even East Asia. China will provide a base for relocating labor-intensive industries that have lost their comparative advantage. Companies may establish themselves in China, not only to address the Chinese market, but also as a venue for manufacturing goods for export. Southeast Asia is also benefiting from the demand created by the rise of China. The demand boost from China is powered by its huge domestic consumption and export-related industries. This increased demand is expected to benefit economies that have re-engineered their export sector 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 16 June 2003 5

6 China: The Dragon's Effect on Southeast Asia to take advantage of this phenomenon. Gartner Dataquest also expects more Chinese companies to globalize and develop world-class brand names. Legend and Haier, key Chinese vendors in their fields, are classic examples of indigenous Chinese companies that have recognized external opportunities and taken steps to leverage those opportunities. Southeast Asian companies could also use their knowledge of the region to take on the role of manufacturing management services providing services such as coordination management, overseeing distribution channels and outsourcing parts of the manufacturing process to various countries in the region. In the longer term, Southeast Asia countries must move up the technology ladder, or they will steadily lose their competitiveness in the electronics manufacturing industry. Smaller economies must seek their own export niches as China floods the world with its manufactured products. Singapore, for example, has retained a large share (about 35 percent) of the world's hard disk drive (HDD) manufacturing. Despite the significant increase in wage and land costs relative to its regional neighbors since the late 1980s, HDD assembly continues to be concentrated in Singapore. Having high-end HDD assembly operations would continue to deepen Singapore's manufacturing capabilities and, more important, a foundation for leveraging into higher-value-adding activities, such as development of key magnetic storage technologies and HDD design. Singapore's nearest neighbor, Malaysia, has also created the Multimedia Super Corridor, which will accelerate progress on the country's Vision 2020 to become a fully developed, mature and knowledge-rich society by 2020. It is designated for the development and delivery of various multimedia products and services, such as hardware chip design, smart card applications and e-learning. Another example is India a huge untapped market in South Asia which has gradually shifted its focus from software to hardware chip design as it seeks to leverage assets such as low labor costs, plentiful engineering talents and growing private sector investments in hardware design. Several design centers have sprung up, particularly in Bangalore, home to most of India's software services industry. Most of these are from the overseas chipmakers such as Intel, ST Microelectronics, Texas Instruments and electronic design automation companies such as Cadence Design System and Synopsis. In the next decade, India is expected to become as dominant in hardware chip design as it has been in software services. While China may pose a threat to the Southeast Asian economies, if various markets can develop their own strengths in the electronic and semiconductor fields, it could be a great opportunity as well. Key issue Which regions in Asia/Pacific are rapidly emerging in the semiconductor industry. 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 16 June 2003

2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 16 June 2003 7

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