DON’T MISS SAIGON
Doing business in Vietnam is better than ever, but still not for the faint-hearted.
By Abe De Ramos

When Than Trong Phuc left Saigon at the end of the Vietnam War in 1975, little did the 14-year-old know that he would one day return to the communist country with the most important foreign investment it has seen to date. With his mother and two brothers, Than had settled in Los Angeles, living with a foster family for a year before they supported themselves with odd jobs. Fascinated by electronics, he took up engineering and eventually became part of the technology-demonstration team of Intel, the largest semiconductor maker in the world, following chairman Craig Barrett wherever he traveled. It was on one of these trips that Than saw how much Vietnam had changed, and since his homecoming in 2000 as country manager, he had been pushing Intel to build a chip factory there. That came to fruition last February, and the US$300m investment might give other companies reason to wonder: What opportunities did Intel see in Vietnam that others could be ignoring? Than has a succinct answer: A lot.

The Intel investment was only the latest vote of confidence on Vietnam’s potential. In the first four months of the year, the country attracted an estimated US$2.3 bn in foreign direct investment, nearly half the amount received in 2005. Nike, the largest athletic-footwear brand in the world, which indirectly employs 138,000 local workers, is raising its scope of activities from just manufacturing to shoe development. Its output from Vietnam could soon equal that from China. And 3M, which makes and sells a range of industrial and consumer products in the local market, just tripled its floor space in what is now Ho Chi Minh City to accommodate its ambitious targets. From sales of US$13m in 2005, 3M expects to make US$20m this year, ballooning to US$100m by 2010. Such stories of optimism should multiply even more when the country enters the World Trade Organization by the end of the year, as many expect.

All the signs of good opportunities for foreign companies are there. In its 2006 ranking of the most cost-competitive investment locations in Asia, the Japan External Trade Organization found Ho Chi Minh City and Hanoi to be the best alternatives to major Chinese cities (see chart, next page). In an April survey of the most attractive emerging markets for retail-oriented multinationals, AT Kearney, a consulting firm, ranked Vietnam third after India and Russia. China, the toast of every global company for years now, comes fifth. Considering that the poor Southeast Asian country only has 84m people – versus 1 bn in India and similar to the more prosperous Philippines – the ranking speaks volumes about the consumption pattern emerging in the young nation. Every country manager in Vietnam stresses that 75% of the population are under the age of 35, half are under 25, and the unemployment rate is a low 5%.

Solid fundamentals back up the hype. Despite a long drought and avian flu, GDP grew 8.4% last year, making Vietnam Asia’s second-fastest growing economy after China. “Vietnam is doing many things right,” says Ifzal Ali, chief economist of the Asian Development Bank. “With rising consumption and investments, it has charted a course of a strong, market-oriented economy.” Investments and reforms should keep growth at 8% in the next two years. For these reasons, some have started to pit Vietnam against China when considering building capacity. The problems of China are well documented, most chronic among them being the shortages in power supply and labor, which have caused operating costs to skyrocket. While conditions in Vietnam are far from ideal – corruption, lack of transparency, and poor infrastructure are constant headaches – the country long overshadowed by its neighbors has bloomed into a viable new location for a diversified Asian strategy.

Blind Faith

“We strongly encourage investors to look at Vietnam as part of a portfolio, but certainly not as a single strategy,” says Richard Ellert, director for supply chain at consulting firm Alvarez & Marsal, in Hong Kong. That is just what Intel did. As it sought to expand its capacity, Intel played safe by taking both an expansion and a ground-up approach; its foray into Vietnam came only two months after investing US$200m into existing facilities in Malaysia. While Intel could have stopped there, it couldn’t resist the cost-arbitrage opportunity in Vietnam – only the fifth country in the world where it has assembly-and-test operations – with market-growth prospects thrown in for good measure. “It boiled down to brownfield versus greenfield,” says Than. “We looked at costs, availability of skilled workforce, infrastructure, government incentives, and strategic growth. Vietnam scored well in those criteria.”

The new Intel factory just outside Ho Chi Minh City, which will employ 1,200 people, will break ground before June, and is expected to ship its first chip in the middle of 2008. To be sure, analysts questioned the investment. For one, little to none of its chips will stay in the local market; Vietnam does not have any meaningful number of manufacturers of products that require them, such as personal computers and mobile phones. The other end of the supply chain is equally bare; being the first chip manufacturer in Vietnam, Intel precedes its suppliers of components and services that it needs for the finished product.

Than accepts both arguments, but counters that the factory in Vietnam will be no different from those in the Philippines and Malaysia, which ship the majority of their output to manufacturers in Taiwan, China, Korea, and Japan. Also, the domestic market – which Than says has only a 5% PC-penetration rate that is growing at 18% to 25% a year – has nowhere to go but up. This gives him the confidence that Intel’s suppliers, and the rest of the PC supply chain, will soon follow.

What Than is upbeat about is the labor-cost arbitrage given the undeveloped yet malleable skills of the local workforce, whose wages cost roughly a third of those in China. (The minimum wage for foreign-invested enterprises is roughly US$55 a month.) Than is first to acknowledge that Intel is placing a radical bet on the supply of skilled workers and engineers. “Vietnam does not have the workforce that already knows how to produce chips and semiconductors,” he says. But with intensive training, Intel, he believes, can raise their skills to upgrade the production in Vietnam from simple chipsets to more complex CPUs, or central processing units, as its Chengdu factory in China does. “We haven’t said that we will do phase-two investment, but if everything goes as well here as in Chengdu, there is no reason why we will not do CPU in the second phase,” says Than.

Than argues that by coming to Vietnam now, Intel’s future productivity will offset any future increases in employee salaries. A late mover, he says, risks paying higher wages for workers at the low end of the learning curve. “As input costs increase, output value has to increase,” he says. “By coming in early, you develop your strategy and local workforce so that they migrate to produce more value, and by virtue of that, you have the cost advantage.” In fact, Than says these limitations are part of the cost strategy. “If you come to a country where the skills are already there, your costs are going to be high,” he says. “When we went to Chengdu and Costa Rica, there was no experienced workforce, but if you know they have potential, you can train them.”

These arguments rely heavily on whether the Vietnamese workers are educated, trainable, and sufficient enough in number in the first place. Than counts on the country’s 97% literacy rate, the state focus on education – a quarter of the population is in school at any given time – and Intel’s own initiatives, such as working with universities to improve their curricula, to overcome the challenge. For senior engineers, Than has identified a recruitment pool. “Lots of Vietnamese who left the country after the war and settled in the US, Europe, and Australia are now engaged in the high-tech sector, so there is potential ‘brainback’,” he says. “Some of them have come back and established high-tech companies, so we’re seeing a steady migration of this type of expertise.”

At Nike, country manager Amanda Tucker puts an equal amount of faith on Vietnam’s ability to move up the value chain, having laid the groundwork to bring shoe development into the country. Until now, the company only produced shoes through its network of Taiwanese and Korean contract manufacturers. Development involves a range of skills – from turning sketches into 2D and 3D designs and analyzing the features of the shoe, to determining the materials to be used, to building the tooling for its production. “Vietnam is starting to grow in its capabilities, and in many ways, developing the products closer to where we manufacture them would help our speed-to-market initiatives,” says Tucker. “We are becoming a source country that can be more involved in the development process.”

Tucker calls it a natural evolution in the rapid growth of Nike in Vietnam. The company first entered in 1995, sourcing from five subcontractors and exporting 5m pairs of shoes. In five years, volume had quintupled to 25m. Last year, it reached 54m, representing 30% of Nike’s total output. This year will see another high double-digit growth rate that could bring the Vietnamese output close to that of China, which accounts for 34% of the total. For now, China, where Nike has been sourcing for 20 years, produces more advanced-design shoes than Vietnam; new models that introduce a new technology – such as the Air Max that replaces the midsole with an airbag – are made in Qingdao. “These shoes require a higher technical expertise, and maybe more complicated tooling, equipment, and machinery,” says Tucker. However, factories in Vietnam are fast catching up. “Some factories are now doing A-level products; the highest is A+,” Tucker adds.

Localize This

At 3M, the challenge is to capture the opportunity presented by Vietnam’s domestic market. Its US$100m sales goal is laminated and hangs next to the desk of country manager Kang Moon-Sung. The Korean national sees growth across all 3M product lines. Since Vietnam became attractive for wood-furniture manufacturing – exports should reach US$2.2 bn this year, up 39% from 2005 – 3M has had a field day growing its abrasives business. And since per capita income soared from US$200 in 1995 to US$543 last year – with private consumption making up 65% of GDP (versus 43% in China) – 3M is bullish about its products that relate to consumer demand, from household cleaning scrubs to adhesives and stationery.

To reach his sales goal, Kang plans to introduce more 3M products in Vietnam, while increasing its local manufacturing and sourcing to make them more affordable. Before, 3M had to import finished goods from the US, China, Taiwan, and Thailand – with high import duties. Now it is importing semi-finished products that have lower duties, and processing them into finished form in its small factory of 50 workers. Abrasives, for example, are imported in big rolls and then cut into sheets according to customer needs. With its strong cash flow – 3M remitted its first dividend of US$1m last year – Kang is now budgeting to expand its manufacturing in Saigon. “We have to hit the right price-point for the domestic market,” says Kang. “With more locally sourced materials and local labor, our prices could be lower than imported finished products.”

At Motorola, country manager David Knapp is busy drumming up wireless products after being in Vietnam for over a decade. Motorola was one of the first multinationals to rush in after the US lifted trade sanctions against its former enemy in 1994. That rush turned out to be a bubble; with complex regulations, poor infrastructure, and weak purchasing power, Vietnam fell short of expectations, and investors subsequently fled. Motorola stayed, providing network equipment to Vinatel, the state-owned mobile-phone company. Motorola has since seen dramatic changes in Hanoi’s attitude to business, and this, coupled with a booming consumer market, has reignited its upbeat take on the country. For example, Vietnam reduced the tariff on imported handsets from 40% to 5%. “That really helped because it wiped out a significant portion of the grey market, which used to account for almost 50% of the market,” Knapp says.

With that problem diminished, Motorola has been quickly gaining market share, with its high-end models RAZR and SLVR as popular as its low-end ones. And as Vietnam eagerly adopts new technologies, new opportunities are opening up for Motorola. Knapp is putting extra focus on selling wireless broadband access, both with its own proprietary technology called Canopy and the standards-based WiMax. “The government issued trial licenses for WiMax and we’re intending to participate in those trials,” says Knapp. “It is certainly heading in the right direction.” Heading towards development, however, has exposed a number of challenges to doing business in Vietnam.

Slippery Slope

With rising real-estate costs and limited distribution channels, Vietnam needs to be approached cautiously. In the retail sector, a country manager for a foreign apparel brand, who asks not to be named, complains that retail space in Saigon’s main shopping street of Dong Khoi has become prohibitively expensive; a 50-square meter space now rents for US$5,000 a month, double what the company can budget for. Richard Townsend, managing director at property advisor CB Richard Ellis, says demand for retail space in Saigon far outstrips supply, and much of the new supply won’t be coming until the next two years. For companies that don’t rely on physical space, the challenge is finding the right distributors. Kang says those with good cash flow management are few and far between. “There are not many acceptable-size local companies that can act as distributors,” says Kang. “Either there are too many small distributors that lack scale, or (a few) big trading companies that have their own agenda.”

Being in a centralized state in transition, multinationals will find participating in public tenders a hair-pulling experience. “Decisions are made quite slowly here,” says Knapp of Motorola. Setting a procurement budget to making a purchase decision can take up to two years. “A lot of people want to know what’s going on, and to make sure that their interests are looked after, you need to get a lot of signatures.” Signs of change are showing. Key state enterprises such as the wire-line provider VNPT are adopting a holding-company model, regionalizing the central structure. “There used to be 64 wireline carriers all reporting to VNPT; now there are only three,” says Knapp. “That will hopefully streamline the procurement process.”

Red tape can also test the patience of multinationals. The country manager of the apparel maker says the company has to apply for a license for each store it plans to open – resulting in a paper trail that goes from local, city, and provincial trade and tax agencies. Advertising materials must be approved by a cultural committee for content, and those deemed risqué are turned down. The system lends itself to corruption, which is already rampant. Paperwork for customs clearances, for example, are arbitrarily delayed unless officers on the ground receive “little green documents” – 100,000 Vietnamese dong notes, or roughly US$6. For the apparel company, which insists on a no-payout policy, such delays can extend to two weeks.

Within the organization, kickbacks are common between suppliers and procurement employees. “You really need a strict and thorough control mechanism if you’re thinking of operating in Vietnam,” he says. Tucker of Nike agrees. “We have to be really careful because of FCPA,” she says, referring to the US Foreign Corrupt Practices Act, which prohibits American companies overseas from, and penalizes them for, engaging in bribery. “We have a no-gift policy, and the reason is to protect the employees. It’s a pretty slippery slope once you start making exceptions.”

The problem gets more serious when state agencies interpret rules differently. 3M, for example, had to pay corporate tax of 20% last year – instead of the 15% it had been granted by the Ministry of Planning and Industry (MPI) – due to conflicting views on its business activities. “When we had our business license, we described our production, packaging, and labeling processes, and the MPI said we’re a manufacturing company,” says Kang. “But the tax guy had a different idea and said, ‘This is a trading process and your tax is 20%.’” Kang decided not to pursue the case. “It could take three months to get a reply from Hanoi, and you may not get the result you want,” he says. Asked if he thought the tax officers in charge were making overtures, Kang replies: “It’s possible, but we would never do it.” Multinationals pin their hopes on a resolution put forward at the Communist Party Congress last month that places elimination of corruption and red tape on the government’s list of priorities.

Bumpy Roads

And there’s no better time for it. Corruption has gotten in the way of infrastructure development that could improve business conditions. Last month, the transportation minister stepped down, and several high-ranking agency officials were suspended, following a scandal involving the embezzlement of millions of dollars of foreign aid that was meant for the construction of roads and bridges. The scandal tarnishes a country where roads from factories of major products like Nike’s are unpaved. “These are major exporters and they’re heading to factories driving over dirt roads,” says Tucker.

Ports are another weakness. “A lot of the traffic that leaves Vietnam is actually feeder traffic – smaller vessels bringing goods to larger ones in Singapore, Hong Kong, or China,” says Ellert of Alvarez & Marsal. “A lot of goods leave Vietnam via rail, go to Nanning (in China) and are transported into ports.” As such, logistics costs in Vietnam can be 30% to 50% higher than in China. Vietnam is also starting to face a power-supply problem. According to local media, the MPI projects a shortage of 1 bn kilowatt hours in 2007, with imbalances until 2010, as electricity consumption grows 15% a year. “The power problem in China is more predictable than in Vietnam,” says Ellert. “China will tell you, ‘On Thursdays you will not have power’; in Vietnam, you never know when you’re going to have power or not, which compromises businesses dependent on just-in-time” logistics.

And like China, Vietnam is facing labor shortages. The country manager of the foreign apparel firm says his factories are constantly lacking experienced sewers. Last month, local media reported a Ministry of Labor survey showing at least 25% of multinationals are seriously short of workers. These companies, the report said, needed 24% more employees and 70% more manual workers. As companies lure workers with even just a US$5 pay increase, turnover is reaching alarming levels. At one factory that manufactures Nike footwear, Tucker says turnover is 2% a month – versus 2% a year on average in its Indonesian factories. That adds up to Nike’s subcontractor churning a quarter of its workforce every year.

Hanoi could also improve its transparency in handling labor issues. A recent confusion on the implementation of a minimum-wage hike for workers of multinational companies resulted in hundreds of illegal strikes, some of them violent. Because the minimum wage had been kept at 636,000 dong (US$40) since 1996, the government had been consulting with multinationals regarding an increase. In early January, a newspaper reported that a 40% rise had taken effect, even as no such action had been declared. Workers demanded the increase, but employers were unable to communicate effectively for lack of clarification from the government. Hanoi finally announced a pay hike later that month – interestingly, 40%. “The issue wasn’t so much that the wage was increased – it was reasonable if it hadn’t been done for ten years – but how it was done and communicated,” says Tucker. Nike has yet to decide how it will react to the increase in labor cost, which accounts for 6% of its total manufacturing cost.

In spite of these challenges, the business community is giving the Vietnamese government plenty of credit for improving the business climate. One such move, motivated by the country’s pending membership to the WTO, will take effect on July 1 and drastically changes the investment environment. Currently, investments of foreign and domestic enterprises are governed by two separate laws. A new law unifies these, which in theory levels the playing field. While a common legal framework has not yet been achieved, and implementing regulations have yet to be issued, this earnest attitude – coupled with the undeniable growth of the domestic economy – keeps investors believing that the benefits of doing business in Vietnam outweigh the risks. “The government has been doing the right things in terms of growing the economy, investing in the workforce, and in infrastructure,” says Than, the country manager of Intel. “It has a single-minded focus to attract a player like Intel.” Needless to say, it has worked.