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Supply Chain Due Diligence: Managing the Shift Away from China

The COVID-19 pandemic threw supply chain resilience into the spotlight. According to Bank of America research, 80 percent of global sectors were confronted with supply chain disruptions almost overnight. But while the pandemic has given this issue more impetus, many businesses have been looking at alternative models for some time. With a drive toward localization and near-shoring, businesses find themselves looking for alternatives to their Chinese supply chains. A recent survey showed that over 40 percent of respondents have already withdrawn some of their production or sourcing from China, or are planning to do so, with many looking closer to home. 

What are the main drivers for moving away from China, what are the alternatives, and how can compliance teams manage supply chain due diligence along the way? Let’s start at the top.

Key Drivers for Moving Away from China

With estimated costs of $1 trillion for firms who want to relocate their Chinese supply chains, these are not decisions taken lightly. While coronavirus has sped up this decision making process, there are multiple reasons why many US and European firms are looking for alternatives to China. For American firms, trade relations with China have played a significant role in the change, with 90 percent of large US companies operating in China saying they have been affected by the dispute, according to a September 2020 law firm survey. Political risk as well as rising labor costs in China have also accelerated the decoupling process.

For other businesses, a growing need for supply chain resilience and stability is driving the change. Rather than using the lowest-cost supplier, which has driven the decision making process for decades, there’s now a premium on quality partnerships. Firms are further looking to diversify their risks instead of putting all their eggs in one basket. Finally, re-shoring of supply chains and localization of production also offers opportunities for greater transparency.

If Not China, Then Where?

Businesses looking for alternatives in Asia have many choices. India is a strong option with a highly-skilled, English-speaking workforce where labor costs have been rising yet are still considered relatively low. Vietnam, Thailand, and Indonesia are also favorable options, with similar, or lower, labor costs that provide significant investment opportunities. Each of these markets offers many positive attributes, but a full understanding of risks, particularly in relation to bribery and corruption in those jurisdictions, is essential.

Looking outside Asia, many US firms are considering Brazil or Mexico as suitable options, with the latter especially favorable in light of the recently ratified United States-Mexico-Canada Agreement (USMCA). Closer to home, Canada and the US are increasingly attractive options, although high production costs and lack of productivity are major concerns.

How do these shifts affect compliance teams?

Whatever the jurisdiction, there are a number of issues compliance teams must be prepared to tackle as the decoupling process from China picks up momentum. Here are six potential scenarios as well as thoughts on how robust supply chain due diligence can help reduce compliance challenges.

1. Establishing new large scale manufacturing sites

For businesses looking to move their manufacturing to another country, there is significant potential for FCPA risk from the early stages of establishment. For sites that are directly owned, land purchase and regulatory approvals pose the first hurdles in developing countries. Local government practices are rife with corruption and bribery and gift giving to local officials is often the norm to enable a trouble-free process.

From a construction perspective, the employment and screening of a myriad potentially small contractors can expose a business to a new level of risk. Managing third-party risk in this situation requires the application of consistent supplier due diligence to ensure your business is not exposed to unethical practices (modern day slavery is one example) and avoidable risk around the build.

2. Employing new management staff

Unless there is a transfer of staff from the previous production site, firms must be prepared to conduct pre-employment screening checks on all new staff and enhanced background screening on senior management in particular. Consistently uncovering red flags, such as local government connections, criminal records, and sanctions violations, is vital for businesses working with new management teams in all potential locations.

3. Evaluating and screening of new logistics partners

Widespread changes to the supply chain will inevitably lead to a requirement to work with new, potentially untested, logistics and distribution partners. Fraud and corruption risks are particular areas of concern. Compliance teams must be prepared to adhere to vendor screening best practices to ensure a resilient supply chain.

4. Managing the reduction of China-based capability

A key aspect of shifting manufacturing from China is managing the winding down of any China-based capability. Labor militancy, such as strikes, disruption, or, in severe circumstances, harassment of foreign management staff may follow news of factory closures due to offshoring. It is essential to fully understand the background of local labor resources by using focused due diligence and investigations skills to make an evidence-based impact risk assessment.

5. Conducting ethical audits in new locations

If production is subcontracted to local companies in new locations, an ethical audit is imperative to provide full transparency on risks that can have a huge impact on an organization’s reputation. Investigations of issues such as forced labor and human trafficking, working conditions, and pollution are required to meet a growing focus on ESG risks by stakeholders.

6. Ensuring FCPA compliance

As regulatory scrutiny remains high, firms should proactively analyze their FCPA compliance programs to ensure they remain up to standard in light of changes to the supply chain. Whether that relates to new jurisdictions or new types of third parties, auditing the suitability of policies, and corresponding communications, is the backbone of any successful supply chain due diligence program that meets FCPA requirements.

No matter the jurisdiction your business operates in, IntegrityRisk can support your supply chain due diligence needs as processes evolve. From ethical audits to maintaining your FCPA compliance program, get in touch to conquer all your risk challenges wherever your supply chain takes you.