Stress Test!
8/29/2022 Markets & Industries News

Stress Test!

More and more companies are bringing procurement back to their home market - or at least close to it. That's good news: Europe has a lot to offer when it comes to procurement. However, there is a catch.

Container ship underneath a bridge

The warning cries cannot be ignored: missing deliveries, scarce semiconductors and skyrocketing prices. Supply chains are in crisis. This is now an ongoing issue not only among buyers, but it also affects the general public due to high inflation. The Corona super crisis was joined in the spring of 2022 by Russia's attack on Ukraine - a war in the middle of Europe. Companies are reacting and looking for ways out.


"We don't see an end to globalization, but we do see a reorientation in supply chains," is how Lisandra Flach, head of the Ifo Center for International Economics, sums up the situation. This reorientation is sorely needed: The Ifo Institute, of which the Ifo Center for International Economics is a part, also collects an index for material scarcity as part of its regular surveys. This had recovered somewhat in early 2022, only to go through the roof in the spring. In individual industries such as electronics and IT, more than 90 percent of companies reported a shortage of materials and inputs. But the situation could get worse before it gets better. Not only is inflation at a record high, but producer prices are currently rising at an all-time high. In April, they rose by 30.9 percent, mainly due to skyrocketing energy and raw material prices. Many companies have not yet passed on these additional costs to their customers. And further trouble is looming from China.


China Disruptive Factor


China's zero-covid policy is now emerging as the biggest risk. The lockdown in Shanghai lasted more than seven weeks in the spring. This is not only a huge burden for the local people, the economy is also suffering immensely. The 25-million metropolis is home to the world's largest container port and is a very important transshipment point for goods heading to Germany. Shanghai is not the only city affected: More than 50 megacities have been affected by lockdowns at times.


These disruptions are not the first in business with China. Numerous giant ports were repeatedly closed during the pandemic and production came to a standstill due to lockdowns or energy shutdowns. In the meantime, the great dependence on China is being viewed critically not only in the capitals, but also in the corporate headquarters. Chinese trade restrictions on Lithuania due to the Taiwan issue have also contributed to this: While China sees Taiwan as a breakaway province and part of China, Lithuania sees Taiwan as an independent state. As a result, China deleted Lithuania from its trade register, and goods and ships from the Baltic state are no longer allowed in by the People's Republic. The Ukraine war and Beijing's commitment to "friendship without borders" with Russia are further increasing the unease.


This is bad news for business relationships and supply chains. From no other country does Germany obtain more goods, including many intermediate products. In 2021, Germany imported goods worth 142 billion euros from China, almost twelve percent of total imports. For many electronics products, China is unrivaled in terms of price, and in the case of key raw materials, Beijing not only strategically secures access to mines, but also controls further processing into end products. Almost half of the German companies surveyed by the Ifo Institute are dependent on primary products from China. The big shift has begun, however: Half of the companies dependent on China want to procure less from the People's Republic in the future. An April 2022 survey by the European Chamber of Commerce in China also found that nearly a quarter of respondents are considering shifting their investments out of China. More than ever before.


Focus on Visegrad Countries


The search for alternatives is therefore in full swing. According to Ifo expert Flach, 80 percent of companies are looking to Europe - both to neighboring EU countries and to other European states. There are four good alternatives right next door: the Visegrád states. Poland, the Czech Republic, Slovakia and Hungary, also known as the V4, have long been a fixture for buyers and are indispensable as a procurement market for German companies.


Since the four countries joined the European Union (EU) in 2004, economic ties with Germany have been developing rapidly. Between 2004 and 2021, bilateral trade in goods between Germany and the V4 countries more than tripled. Together, the V4 are Germany's most important foreign trade partner: In 2021, Germany procured goods worth around 166 billion euros from the four countries, according to the Federal Statistical Office. That is 24 billion euros more than from China. The V4 now account for just under 14 percent of Germany's total imports. Industrial products traditionally play an important role in mutual trade.


The high volume of trade is largely attributable to subsidiaries of German companies. At the end of 2020, the stock of German direct investment in the V4 countries totaled around 90 billion euros, according to the Bundesbank. As a production location, East-Central Europe is firmly integrated into the value chains of the German economy. The inflow continues unabated and could increase in the future.


According to the foreign chambers of commerce in the region, German companies have been intensively looking for new suppliers or suitable investment locations since the pandemic. Lars Gutheil, managing director of the German-Polish Chamber of Industry and Commerce, expects companies to increasingly rely on regional rather than global supply chains over the next five years. "Countries such as Poland will continue to gain in importance as a location for nearshoring."


For Hans Boot, purchasing expert at the consulting firm Durch Denken Vorne Consult, this is due, among other things, to the low risk of the region. He mainly advises medium-sized companies on supply chain management and observes a trend: "Due to increased logistics costs, the difference in the purchase price of a product between Asia and Europe is no longer so decisive. Instead, many companies are once again relying on nearby sources of supply to minimize risks," says Boot.


No Longer the Extended Workbench


In addition to their geographical proximity to Germany, the V4 countries score with location factors such as a well-developed transport infrastructure. This means that short and flexible delivery times to Germany are not normally a problem. Border controls and other trade barriers do not exist thanks to EU membership. Investors and buyers also appreciate the V4 for its above-average labor productivity compared to the EU, with internationally competitive cost structures. "In the past ten years, many companies in Central and Eastern Europe have optimized their manufacturing and administrative processes and in many cases can keep up with prices from Asia," says sourcing expert Boot.


However, the V4s have long since ceased to be an extended workbench for inexpensive parts with low vertical integration. Numerous small companies have mastered complex manufacturing processes, can thus offer high quality and meet demanding standards. The V4 countries are also increasingly becoming powerful partners for research and development. German companies can therefore draw on a dense network of qualified suppliers there and thus diversify their procurement.


Large automotive manufacturers in particular have discovered the region for themselves. Vehicles and automotive parts are a central pillar of the export success of all V4 countries. The Czech Republic is Germany's largest supplier of automotive parts. In Slovakia, more cars are built per capita than anywhere else in the world. Hungaryis specializing more and more in electromobility.

Trade and investment relations with Germany are also pronounced in the closely related metalworking and rubber and plastics industries. The V4 are also of interest to buyers from the mechanical and plant engineering, electrical engineering and chemical industries.


Order Books are Full


Especially for medium-sized German companies, Central and Eastern Europe is an excellent procurement market. Companies in the V4 countries, for example, are good suppliers for sophisticated special and drawing parts. "Central and Eastern Europe is particularly worthwhile for small batch sizes," says sourcing expert Boot. Many companies in the region focus quite specifically on individual small batches for medium-sized companies. "Also because they achieve higher margins with this than with large-scale production and are not so easily interchangeable."


Despite or precisely because of current crises such as the pandemic and the Ukraine war, many companies in the V4 countries are working to capacity. Demand for goods from suppliers in Central and Eastern Europe is increasing. "The order books of Eastern European companies are well filled. Therefore, it is currently difficult to find suppliers in these countries who have free capacities at short notice. But not impossible either," says purchasing consultant Boot. He advises buyers to approach the search strategically and take a long-term view. "Start building partners for the future now."


Shooting Star Western Balkans


The Western Balkans have established themselves as the secret shooting star among procurement alternatives. Located on the EU's doorstep, with competitive cost structures, there is currently hardly a better choice for simpler supply chains. Trucks reach the six countries of Albania, Bosnia and Herzegovina, Kosovo, Montenegro, northern Macedonia and Serbia from Germany within a day. No wonder, then, that a purchasing initiative for the Western Balkans funded by the German Federal Ministry for Economic Affairs and Climate Protection in the fall of 2021 met with keen interest.

Bilateral trade between Germany and the six Western Balkan states has been growing dynamically for years: Between 2015 and 2021, it increased by almost 75 percent in nominal terms to around 14 billion euros. Although the corona pandemic caused a brief break in 2020, the pre-crisis level has already been significantly exceeded. One advantage of the region is the Stabilization and Association Agreement with the EU: Most goods can be traded almost duty-free.


German companies are investing in the Western Balkans, especially in the automotive supply sector. Continental, ZF, Brose and Bosch are already on site. Soon, the first electric car could even roll off the production line in Serbia: Starting in 2024, automaker Fiat plans to produce the electric version of its 500 model in Kragujevac, Serbia. There are also opportunities for procurement in the metal processing, wood and furniture, clothing, agriculture and IT sectors.


Foreign companies usually start their business relations in the Western Balkans with contract manufacturing orders and outsource especially labor-intensive manufacturing steps to local service providers. In this way, the clients benefit from favorable labor costs. In the further course, they then invest in the qualification of the supplier or the modernization of the machinery.


From Mass-Produced Goods to Designer Pieces


One of the key industries in the region is the metal processing industry, which is characterized by small and medium-sized enterprises. Metal processing is strongest in Serbia, with exports from the sector reaching over 2.5 billion euros in 2021. There are numerous opportunities here for automotive suppliers, tool manufacturers and casting specialists.

Serbia's agriculture is a regional leader and today produces more than half of the agricultural products in the Western Balkans. In some areas, the country even ranks among the international leaders, for example in the cultivation of raspberries. Around 60 percent of all frozen raspberries in the EU come from Serbia. There is also potential here in contract farming. Here, companies first work together with local suppliers and then process the products locally or abroad.


The wood and furniture industry does not have to hide either. It can draw on an excellent raw material base. In Bosnia and Herzegovina alone, 50 percent of the land is covered by forest. Ikea and other furniture giants use the region as a procurement market. But designer pieces also come from the Western Balkans: Awards such as the Red Dot Design Award have gone several times to companies from the region.


Political Instability is Biggest Risk


The political situation in the region remains complex. The political situation in the region remains complex, especially in Bosnia and Herzegovina, where one part of the country, the Republic of Srpska, is threatening to secede. The ongoing conflict between Serbia and Kosovo has also not been resolved. And in Montenegro and northern Macedonia, governments resigned or were voted out of office only at the beginning of the year.


Nevertheless, the interest of political actors in investments, increasing exports and EU subsidies is very high - and therefore these enjoy priority. Governments also provide massive support to small and medium-sized enterprises. In Serbia, for example, President Aleksandar Vučić is particularly keen to attract German investors and regularly cuts the red ribbon at site openings.


North Africa Scores with Proximity to Europe


However, turning away from China does not mean that German companies are turning their backs on Asia completely. On the contrary, they have been pursuing the "China Plus One" strategy for several years, from which they are now benefiting. This strategy serves to spread risk and focuses in particular on the countries of Southeast Asia. In 2021, Germany imported goods worth 50 billion US dollars from the ten Asean countries Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam.

Due to the low wages, these are mostly labor-intensive products such as clothing and shoes from Vietnam or furniture and wood products from Indonesia. But electronics are also increasingly being assembled in the Asean states. Cambodia, for example, has become the largest supplier of bicycles to Germany, thanks to Taiwanese manufacturers producing there. However, the Asean states are very heterogeneous, for example in the level of education, which makes doing business difficult. Added to this is the high dependence on imported primary products and the geographical distance from Germany.

That's why more and more companies are turning to a closer sourcing alternative: North Africa. High-performance ports such as Tangier in Morocco connect Europe and North Africa, usually in less than 24 hours. In addition, qualified personnel are available at comparatively low labor costs. European companies produce textiles and electronic components for the export market in Morocco and Tunisia. In addition, more and more companies from the automotive industry are settling in Morocco. Its importance as a trading partner for Germany is also growing: In 2021, German importers paid 8.5 billion euros for goods from the North African countries - although around half of this was for oil and gas. In the future, the region could also supply green hydrogen for energy transformation in Germany.

The alternatives to China are therefore many and varied. But in the search for alternatives, companies should not forget that they must also keep an eye on classic risks in their reorientation: For example, there is still a shortage of containers and truck drivers in many places, which further exacerbates the tense supply chain situation. And two risk areas are likely to continue booming: the changing world order is producing political risks, and climate change is making catastrophic natural events more frequent. So risk management and diversification remain the order of the day.


Source: from Markets International, issue 04/22 | 

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