10 reasons for opening a garment manufacturing business in Vietnam. Figure 1: Engineering graduates in numbers

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1 Investing in Vietnam s garment industry ffers mre than just Free Trade with 52 natins. Risks f nt becming a garment player in Vietnam, which can be translated in a cmpany s cmpetitive disadvantage, are ften underestimated. BDG has gathered 10 reasns why yu shuld cnsider establishing yur garment manufacturing business in Vietnam NOW Vietnam - the new manufacturing hub There have been a lt f discussins why Vietnam is abut t becme the wrld s manufacturing hub. Let us draw sme facts. Based n the thery f cmparative advantages, a cuntry shuld allcate its prductin factrs in a sectr where it has its largest endwments. Once industrialized natins became expensive fr in-cuntry prductin, manufacturing cmpanies mved their plants frm Eurpe and the US t ther cuntries a natural prcess ppulist pliticians use as their arguments in prtectinist campaigns. While China nwadays attracts mre manufacturing cmpanies that require specific knw-hw (thus earning higher mnetary values), Vietnam and Mexic are tw examples f cuntries which are stepping in. Why culd Vietnam have cmparative advantages in lwer-level manufacturing gds? It culd be the cmbinatin f the enrmus number f engineering graduates and the general educatin level f its peple. Having a lk at the number f engineering graduates per year in the wrld, Vietnam ranks 10 th (Figure 1). On the ther side, Vietnam still lacks a generally elevated educatin level as recent investments in the educatin system will nly pay ff slwly. Accrding t the Hani Institute fr Sciecnmic Develpment Studies, between 40 and 60% f Vietnam s wrkfrce is unskilled. Thus, while Vietnam will slwly be able t send lcal engineers int the manufacturing sectr, the manufactured prducts will yet lack high cmplexity. Figure 1: Engineering graduates in numbers Surce: WEF 2015/UNESCO Institute fr Statistics / Graphic by Frbes Sme peple might see this as a prblem fr the sustainable develpment f the cuntry. On the ther hand, Vietnam culd use this situatin t psitin as the glbal manufacturing hub fr less-cmplex prductin, while slwly increasing it in the years t cme. Thus, the chances fr the Vietnamese garment industry t grw in the lng run culd be high. 2. Labr prductivity levels in garment manufacturing culd reach the nes f China, but at mre cmpetitive wage csts In an envirnment where labr csts rise faster than labr prductivity, a cuntry wuld becme less cmpetitive and will thus be vulnerable t a pssibility f its manufacturing sectr relcating elsewhere. While we have seen a lt f relcatin frm the US and Eurpe t China, Mexic and finally Vietnam in the past decades, the questin fr the Sutheast Asian cuntry is: culd prductivity gains keep abreast f the salary rises? Vietnam has seen sme verall prductivity gains in recent years, while labr csts rse at abut twice the pace. BDG published a study in 2015 stating that the lack f prductivity can nly be re-established if either the Vietnamese Dng is devaluated r wages are cut. Since wage cuts are plitically prblematic, BDG expects the devaluatin f the lcal currency Dng t accelerate in the cming years.

Figure 2: The cmpetitiveness gap 2011-15 persistence when ding detail-riented wrk. What des this mean fr the future f manufacturing in the cuntry?

The challenge will be t instruct the wrkers using an apprach which they will understand, while als putting a lt f attentin t intercultural differences. 4.

2 Figure 2: The cmpetitiveness gap persistence when ding detail-riented wrk. What des this mean fr the future f manufacturing in the cuntry? Labr intensemanufacturing, including garment, can have a bright future in Vietnam. The challenge will be t instruct the wrkers using an apprach which they will understand, while als putting a lt f attentin t intercultural differences. 4. Vietnam s strategic gegraphic psitin Surce: The Wrld Bank/GSO; Graphic via anda.cm Hwever, there are ways t lift prductivity in Vietnam. Mr. JG Cheng, garment manufacturing cnsultant and specialist fr the Vietnamese garment market says: When yu understand the Vietnamese market, achieve t set the right incentives fr wrkers and manage the factry with cultural awareness, yu will be able t achieve prductivity levels cmparable t China. If garment manufacturers perating in Vietnam achieve China s prductivity levels, the garment industry in Vietnam can be established as a successful industry fr at least tw upcming decades. 3. The astnishing skills f the unskilled If yu have ever visited Vietnam as a turist r travelled arund the cuntry n a business trip, yu might have seen astnishing wrks alng the lcal rads. Yu culd see fr example life-sized Image via freshinterir.me marble sculptures r wden chairs with filigree-carving arm-rests. Smetimes, yu will meet peple wh embrider several-meter large landscapes depicting every detail f Vietnam cuntryside s beauty. All f the creatrs wuld prbably be classified in the sectin f the unskilled. Vietnamese peple ften shw a remarkable Being situated just next t China and its already develped supply chain is anther very imprtant reasn why setting up a garment manufacturing business in Vietnam shuld be cnsidered as we speak. Furthermre, Vietnam s psitin in the heart f Sutheast Asian regin is interesting in terms f bth cmpleting the supply chain and fr future sales, since Vietnam still cannt prduce all yarns and fabrics itself, despite remarkable imprvements in the recent times. While garment manufacturing is develping fast, Vietnam is still dependent n fabric and yarn imprts frm China and ther cuntries. Thanks t its prximity, Vietnam can imprt the necessary prducts within a very shrt time, while enjying beneficial tax rates. Shipping gds frm China, including custm clearance, can nwadays be dne in an average f arund tw weeks. Hwever, when imprting yarn and fabrics frm China, Rules f Origin fr sme Free Trade Agreements (FTAs) will nt apply fr the end prduct. With its rapid develpment and fcus n an ever mre cnsumer riented ecnmy, China might becme an interesting market fr garment exprt in the near future. Even thugh China is still far away frm becming a net imprter f garment prducts, this can change with further rising salary levels and develpment f the cuntry s remte areas. Based n the data frm China Natinal Garment Assciatin, despite slwer ecnmic grwth in the recent years, garment sales are still rising at duble digit levels. While China maintains a highly cmpetitive psitin in the

3 wrld garment market, it will prbably take anther decade r tw fr the cuntry t becme an attractive market fr garment imprts. Psitining early in Vietnam s market culd be a big advantage fr the future. 5. Curbed inflatin and slwer rising wage csts (real wages) Since the garment manufacturing industry has traditinally been extremely glbalized, salaries are usually mentined first when it cmes t measuring the cmpetitiveness level f a territry. In Vietnam, the minimum wages have been increasing strngly in the past six years. While wages almst dubled, investrs have becme increasingly wrried abut the pace f the wage hikes since prductivity gains in mst industries culd nt keep pace. Hwever, there is a trend fr slwer wage rises as decisin makers have becme aware f the negative effects f verall cmpetitiveness. This develpment will lwer the pressure f internatinal garment manufacturers in Vietnam when cmpeting with manufacturers frm ther natins. Table 1: Minimum wages rise and inflatin Year Min. wage regin IV in Mi. VND/ (USD) 1.4 (~USD 67) 1.65 (~USD 78) 1.9 (~USD 90) 2.15 (~USD 97) 2.4 (~USD 108) 2.6 (~USD 117) %YY % 17.9% 15.2% 13.2% 11.7% 8.3% Min. wage regin I in Mi. VND/ (USD) 2 (~USD 96) 2.35 (~USD 112) 2.7 (~USD 127) 3.1 (~USD 140) 3.5 (~USD 158) 3.75 (~USD 169) % YY + CPI 29% 9.1% 17.5% 6.6% 14.9% 4.1% 14.8% 0.6% 12.9% 1.3% 7.1% Surce: GSO; Oanda.cm; USD cnversin at year-end exchange rates 4.8% (est.) Slwer wage grwth cmbined with a decent inflatin rate are a gd sign fr new garment manufacturing wners wh cnsider an investment in the cuntry. In additin, given the fact that Vietnamese wrkers can achieve appealing prductivity levels, factry wners shuld fcus n training their wrkers t increase their cmpetitiveness n a lng run instead f wrrying abut rising cst levels t much. 6. Sme market entry barriers likely t rise in the future Theries abut the ideal timing when entering a new market state that as a first mver, an rganizatin can have lw market entry barriers due t lwer investment csts, little cmpetitin and availability f abundant wrkfrce. The dwnside fr having firstmver advantages is a higher risk f failure because first-mvers ften make mistakes in a new business envirnment. With the develpment f a new market, market entry barriers becme higher. This is already the case fr Vietnam as the cuntry is n lnger a first-mver cuntry fr investrs. Currently, freign investrs are in the psitin t learn frm each ther, while the market in general has becme mre transparent ver the years. When cnsidering a market entry, garment manufacturers ask themselves abut the current maturity level f the Vietnamese market and whether the right time fr an investment is nw r in a cuple f years. Als, they wnder whether Vietnam will sn becme t expensive and manufacturing will again mve t ther cuntries. We are cnvinced that Vietnam is ging t be a manufacturing hub and that the business envirnment will remain investr-friendly fr a lng time. The trend f rising manufacturing csts will cntinue, but we dubt that investrs will withdraw frm the cuntry very sn. Let us have a lk at the reasns: If csts wuld further be n the rise, there are nt many ther cuntries in the wrld where

garment manufacturers wuld find the fllwing market cnditins: reasnable wages, plitical stability, established supply chains, well entrenched lgistics slutins, direct market access t Asia, mtivated

4 garment manufacturers wuld find the fllwing market cnditins: reasnable wages, plitical stability, established supply chains, well entrenched lgistics slutins, direct market access t Asia, mtivated wrkers and thus a prmising basis fr further prductivity gains in the future. Despite sme neighbring cuntries such as Myanmar r cuntries in East Africa which ffer gd business pprtunities, we believe that the time f big relcatin mves fr keeping prductin cst at lw levels is sn cming t an end. New trends in garment manufacturing might be further advances in autmatin f prductin prcesses and increasing endcnsumer prices cmbined with lwer prfit margins. If garment manufacturers want t be prepared fr this develpment, they need t find a lcatin fr their prductin which is well integrated in the glbal supply chain and enjys favrable cnditins fr glbal trade. While Vietnam is currently building its integratin in the glbal supply chain, there is hardly any ther cuntry in Asia having as many FTAs as Vietnam. The advantages which g far beynd lw labr csts are the reasn why garment manufacturers shuld enter the Vietnamese market nw befre further market entry barriers will cntinue t rise. 7. Many regins with abundant wrkfrce: mving frm the cities t the cuntryside Did yu knw that there are 5 millin wrkers in the Mekng Delta (Suth Vietnam) wrking in agriculture? The Mekng Delta is ne f the regins in Vietnam where there is still abundant wrkfrce. With nearly all regins being in zne IV (the mst beneficial regin in terms f labr csts) it becmes bvius that sme remte areas can be attractive destinatins fr labr intense cmpanies. H Chi Minh City and Hani labr csts have almst reached levels cmparable t average wages in China. Thus, it might be attractive fr new investrs t find a prductin site fr their factry in the cuntryside. The fllwing reasns depict why yu shuld cnsider a factry setup in the cuntryside: Majrity f labrers still wrk in agriculture, and earn lw salaries. Wrking in the garment sectr culd imprve their lives; Wage levels are rughly 30% lwer cmpared t the urban areas f Vietnam; While it has becme difficult t find enugh qualified wrkers in sme garment hubs (bth urban and rural), labr cmpetitin in the cuntryside is in general weaker; Imprving infrastructure cnditins enable the set-up f an effective lgistics chain; Many rural areas give tax incentives fr new investments. 8. Factry disaster such as the Rana Plaza are unlikely t happen in Vietnam due t security standards and labr cnditins Rana Plaza (Bangladesh) stands fr ne f the biggest disasters in the 21 st century, with mre than 1100 dead and 2400 injured peple. Althugh Rana Plaza was clsed due t flaws in the building s structure n the day f the tragedy, sme garment business wners frced their wrkers t cme t wrk. In the mnths after the disaster, there were a lt f discussins abut safety f lw-cst wrkers and the fair value f a piece f garment in general. Tday, it seems t be frgtten what mved the wrld 3 years ag. Cnditins fr wrkers have nt substantially imprved in Bangladesh, despite new rules, regulatins and frced factry clse-dwns. Accidents such as the ne at Rana Plaza culd still

5 happen and wuld thus further endanger the image f the garment industry. Shuld there be mre such incidents caused by negligence f wrkers safety in the future, cnsumers might cnsequently becme mre aware f the rigin f the clthes they wear. Garment prducers put themselves at risk if they prduce in a cuntry which applies lw security standards fr their wrkers, des nt fight cnsequently against child labr r which pays miserable salaries. Vietnam has always applied strict rules when it cmes t wrker security, child labr and security f buildings is analyzed prfundly when applying fr a cnstructin permissin. Thus, we believe that a secnd Rana Plaza in Vietnam is unlikely. Fr garment manufacturers wh d nt want t endanger their reputatin due t negligence f their wrkers, disasters r child labr, Vietnam is a gd place t prduce. 9. The cuntry s further integratin in the wrld ecnmy Individually, r thrugh the ASEAN, Vietnam signed FTAs with 52 natins acrss the glbe. With the EU-Vietnam FTA and TPP awaiting t be ratified, this Sutheast Asian cuntry will becme ne f the mst cnnected nes in the regin when it cmes t wrld trade. Knwing that the cuntry nly started pening its barders in 1986, and that it became a member f the Wrld Trade Organizatin just 9 years ag, the vast number f signed FTAs is even mre impressive. Fr mre infrmatin abut Free Trade please refer t anther BDG study. Vietnam has been lacking f supprting industries in the past, there is nw sme mvement. Yet tday, 85% f fabrics and 85% f finished fabrics are still imprted frm ther cuntries, mainly China, Taiwan and Suth Krea. The yarn prductin is nw at a lcalizatin rate f arund 50%. Even with these inadequate numbers, it is likely that the situatin fr lcal surcing will further imprve, and that ever mre garment manufacturers in Vietnam will be able t take advantage f preferential tariffs due t lcal surcing. Accrding t the decisin f the gvernment (36/2008/QD-TTg) dated in 2008 Vietnam is suppsed t achieve a lcalizatin rate f 70% by Even thugh it might be difficult t achieve the gal by 2020, we are seeing cntinuus investments in the supprting industries. Vinatex, the biggest lcal prducer f garment fr example, annunced after its 2015 IPO that it will invest clse t USD 500 millin in new prductin facilities, including fabric and yarn making. While Vinatex had a lcalizatin rate f ver 50% in 2013, the cmpany wants t further increase this figure and cmply with all relevant internatinal FTA requirements Authr: Manuel Wendle, BDG Vietnam Octber, 2016 BDG Vietnam Tel cntact@bdg-vietnam.cm Fr additinal infrmatin and publicatins please visit ur webpage: bdg-vietnam.cm 10. Investments in supprting industries in prcess In FTA such as EU-Vietnam FTA r TPP, we wuld like t pay attentin t the requirement that a certain share f the wrk and basic prducts needs t be prduced and manufactured within a single cuntry, thus requiring strng supprting industries. While

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