In many ways, Vietnam is a great object lesson on how emerging economies transition from being poor and under-developed, then to a nascent emerging economy, and hopefully ultimately to a country with a viable middle class. All sorts of challenges present themselves to a country in the midst of this transition, not least of which is escaping the classic “middle income trap” that so many pundits are concerned China might be ready to fall into; however, looking at Vietnam today offers companies the opportunity to reflect not only on what they should be / could be doing in the country, but also whether they are managing the transition other emerging economies they are working within are in the midst of as well.
Vietnam’s impressive GDP growth owes much of its success to the transition from agriculture to manufacturing. Sounds familiar, right? After all, that’s what drove much of China’s impressive growth as well. Today, Vietnam is fighting off terrible inflation (check out the chart below showing December 2011’s published inflation rate of 18.1% – ouch). Not unlike the omnipresent worries about inflation in China between 1994-1995, when the country’s CPI was running between 20-27%). Today, Vietnam is struggling to deal with problems in its banking system where its state-owned banks have lent money to state owned enterprises (SOEs), in many cases making investments that aren’t going to be paid back. Again, a similar problem China has faced, and one that keeps many government planners in Beijing up at nights even today.
We see in Vietnam many of the same growing pains that China has in some cases already gone through, and in other cases is still in the midst of itself. For companies that were early into Vietnam, much of what animated their decision was the belief that they could use Vietnam as a hedge against wage inflation coming out of China. Now, as Vietnam’s labor force growth dramatically slows, this hedging strategy may be nearing an end unless the country can dramatically improve its manufacturing productivity, a topic of note in the February 2012 report on Vietnam from McKinsey Global Institute titled “Sustaining Vietnam’s Growth: the Productivity Challenge.”
The question now becomes more pressing for companies operating in Vietnam: why are they going to stay in the country? If in fact the country’s wage rates are likely to dramatically increase in the near term – both as a function of the ongoing problems the government is having controlling inflation as well as a function of diminished workers in the labor pool – can you afford to stay in Vietnam given its other challenges? The McKinsey report makes note of the problems several multinational executives with facilities in Vietnam shared; namely, that basic problems with infrastructure (including the country’s power grid) and logistics remain challenging. What once was a bet you could afford to make – staying in Vietnam to hedge against risks in China – now appears to be less relevant. And, if you have to deal with fundamental inadequate infrastructure issues, a lot of manufacturing heavy industries are going to get serious about going elsewhere (and, I would put good money that many will move back into China).
Consequently, companies will have to revisit why they are in Vietnam in the first place. Many will ask, as they did years ago in China, whether they can sell to the Vietnamese consumer. Others, like the McKinsey report notes, will use Vietnam as a staging point to sell into other countries such as Laos and Cambodia. Others will turn their attention to what I found absolutely fascinating in the McKinsey report: developing Vietnam as a source for attracting and selling to Chinese tourists. They note “Vietnam’s location and its long coastline give the country a strong starting position from which to become an early mover in the growing Chinese middle-class market. The elimination of visa requirements for tourists intending to visit the southern island of Phu Quoc, Vietnam’s largest, where plans for major resorts and casinos are being actively discussed, is one such opportunity to attract a new segment of tourists.”
Perhaps the days of Vietnam being a hedging strategy for your company are over. That’s unfortunate not only for the country, but also given it throws up in the air the next part of the undeveloped world where you need to start thinking about finding a supply chain (if that even remains a possibility). But just maybe Vietnam can play another role for your firm: possibly as a target market for you to talk to or take care of Chinese middle-class consumers on some of their first foreign excursions? Few opportunities to more dramatically shape purchasing decisions of Chinese consumers exist than grabbing their attention while on vacation. Regardless, your company’s strategy in Vietnam is going to have to change. That is part of what makes the transition Vietnam is going through so important: yes, initially making product in and exporting from the country was what drove companies in. But it was those companies with an eye towards more than just that – to selling to Vietnam’s domestic consumers, or to using Vietnam as a platform to sell into other small regional economies – that may ultimately benefit the most. It’s a similar pivot a lot of SMEs are struggling to make in a much bigger economy – China – as the days of easy and cheap sourcing are coming to an end and the larger question of how to sell into the market becomes increasingly important.