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Global tech firms are loosening their China ties. Production disruptions in China during the pandemic, geopolitical tension, and escalating restrictions on tech exports are prompting firms to address concentration risk. The moves from China will be financially and operationally challenging.

S&P Global Ratings believes the transition will strain efficiencies and may consume much management focus over the next three to five years. Moreover, firms that move capacity out of China risk losing some access to that market, which many entities rely on for much of their growth.

In our view, the process will only be modestly credit negative for our rated portfolio over the period. The limited impact underscores the strength of these firms, their substantial financial resources, and their managerial expertise on global supply chains.

With tech firms preparing for a redistribution of manufacturing capacity out of China, we estimate China's share of global laptop production will drop by at least 10-20 percentage points by 2025 from over 80% in 2021. The share of handset production would shrink by 5-15 percentage points in the same period. Meanwhile, the proportion of iPhones that Apple Inc. makes in India will likely at least double by 2025, from around mid-single digit percentage of total production in 2022.

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There are positives. Such moves would fortify firms' supply chains and operations against disruptive events, such as abrupt, country-specific shifts in the business or regulatory climate. Rising wages in China are also pushing diversification for labor-intensive tech manufacturers.

Countries across U.S., India, Japan, Korea, and the EU are also offering sizable subsidies to develop critical industries domestically, adding inducements to reshuffle supply chains.

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Ex-China Supply Lines Will Be Costly And Inefficient

Spreading out operations won't be as efficient as utilizing giant factories in China, which maximize economies of scale and draw on existing robust supplier networks, infrastructure, and talent pools. Some companies may retain redundant capacity in China in case they encounter production hiccups while ramping up new sites.

Costs are even higher for those companies that are moving to developed markets. We estimate, for example, that the operating expenses of Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) will be 40% higher at a planned Arizona facility, versus a plant in its home market (see TSMC box).

The reshaping of supply chains will likely dampen the profitability of an array of tech firms and their suppliers for next three to five years. This would likely be the case until new, more geographically dispersed global supply chains solidify.

Higher costs may not be fully passed through to end customers, given intense competition. In addition, large, lumpy expenditure on new plants and supply chains and incremental working capital usage would add cash flow volatility to these firms.

Our rated tech companies will be among key participants in reshaping the global tech supply lines. They are approaching this cautiously. As such, most rated entities should have sufficient buffers to manage the shift and will likely manage contingencies without significant ratings pressure.

We expect TSMC's launch of its U.S. operations from 2026 will hit its profits. The fab it is building in Arizona will alone cost US$40 billion.

Electronic manufacturing services (EMS) companies in Taiwan should be more able to manage the supply-chain diversification than their peers in mainland China, given their established presence in countries such as Vietnam, India, and Mexico. The Taiwan firms are more experienced in global supply chain management. Further, staff training is less complex for EMS firms than many other tech sub-sectors.

Overview By Select Tech Subsectors

Semiconductors

We expect semiconductor manufacturers to increasingly invest in new capacity in the U.S., the EU, and Japan, among other markets outside of Greater China. This will improve supply chain stability and help address escalating U.S. restrictions on tech exports to China. Generous subsidies from countries striving to localize semiconductor production will partly offset the cost of these moves.

According to the Semiconductor Industry Association, over US$210 billion in new private investment in manufacturing capacity has been announced in the U.S. as of March 2023, spurred by the Chips Act.

However, building new production sites will require coordinated moves by business partners and will rely on an ample supply of skilled workers. In addition, manufacturing in developed countries involves higher costs (construction, labor, materials, energy, and back-end services) and reduced economies of scale. This contrasts with the existing state of play: concentrated production using well-developed supply chains, largely in Greater China.

Building new production sites would create a knock-on effect on the profitability of the semiconductor value chain. Separately, some government incentives are conditional. Subsidy recipients under the U.S. Chips Act, for instance, are prohibited from investing in the production of advanced chips in China for 10 years. This limits their flexibility to adapt to evolving technology and operating environments.

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Electronic manufacturing services and electronics components

We believe entities in the labor-intensive and cost-sensitive EMS subsectors will continue to ramp up investments in developing countries outside China. EMS firms have been diversifying their supply chains since the outbreak of the U.S.-China trade conflict in 2018.

EMS customers with significant sales outside of China are asking for this diversification. Examples include Apple, Dell Inc., and Hewlett Packard Enterprise Co. Component producers and other tech hardware companies that supply the EMS firms are following suit.

The upfront investment in a new supply line is relatively low for EMS firms. Yet for electronics components producers that are more reliant on machinery and equipment, capital expenditure on new plants can be substantial, hitting their cash flow.

However, the challenges to these two subsectors are mainly about operating efficiency. A more geographically diverse production footprint implies each production site is smaller, with weaker economies of scale. Managing a workforce, logistics, inventories, production yields, and the like in multiple locations also adds complexity to operations. This also squeezes profits.

Vietnam, India, and Mexico are among firms' top choices to build their new plants,due to the countries' ample young workers and low labor costs.

Mexico is also next door to, and has a free-trade agreement with, the giant U.S. market. Production of home appliances, personal computers, and data centers is moving to Mexico from China. Likewise, EMS firms increasingly deploy resources to Mexico to service the electric vehicle sector.

We also anticipate India's share in global iPhone assembly, including premium models, to at least double in three to four years from mid-single digit percentage in 2022, as dominant iPhone makers Hon Hai and Pegatron quickly build capacity in the country.

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This all speaks to the steepening political imperative on global tech firms to reduce their reliance on mainland China. The moves will be an expensive, disruptive process, involving lots of lost productivity and stranded assets, and possible lost access to mainland Chinese market. Firms are not doing this because it makes sense from a business, operations, or credit perspective. It is, and will be, deeply political.

Writer: Jasper Moiseiwitsch

Digital designer: Evy Cheung

Related Research

• Technology And Geopolitics: What If The Semiconductor Industry Bifurcates?, Nov. 14, 2022
• Tech Stability Wobbles On Rocky Macroeconomics Despite Anticipated Supply Chain Relief, July 14, 2022
• Cutting China From Supply Chains--Easy To Say, Hard To Do, June 1, 2022
• HP Inc.'s PC Growth Dampened By Supply Chain Challenges; Profits Strong, Aug. 28, 2021