Saturday, October 4, 2014

The burgeoning opportunity in Ethiopia’s factories


By PAUL CALLAN AND SANCHALI PAL

A factory whirring with dozens of technicians producing high-quality sportswear is an atypical image of Africa. For a long time, Africa’s potential has been defined by its abundant natural resources.

Yet this story may be changing as a handful of African economies try to follow the path paved by the Asian ‘Tigers’ before them – to become global manufacturing centers.

African countries lack the industrial capability that their Asian counterparts have refined over the last 50 years, but high and rising costs in current manufacturing zones have created an opportunity for them to make up for this lack of experience with cost savings. Wages in China rose 20 percent from 2007-2011, and the appreciating renminbi, along with increasing land and water scarcity, is driving up cost of production. Wages in Vietnam are rising as fast, if not faster than those in China. These changes have already led to a jump in manufacturing investment in Indonesia, Thailand, Malaysia, the Philippines and Bangladesh – but all five countries recently approved significant increases in their minimum wage.



As a result, global retailers are looking further afield to diversify manufacturing and reduce dependency on China and southeast Asia. Countries like Kenya, Tanzania, Egypt, Morocco, and Mauritius have already become common manufacturing locations. But the latest rising star is Ethiopia.

The Addis appeal

A few converging factors have primed Ethiopia to evolve into an important manufacturing centre. First, treaties like the African Growth and Opportunity Act (Agoa) give it – and other sub-Saharan countries – a competitive advantage over Asian counterparts in light manufacturing. Agoa, passed by the US Congress in 2000, enables tariff and quota-free access for imports from sub-Saharan Africa to the US, while  goods from Asia are subject to fees and restrictions. Analogous treaties offer duty and quota-free access to European and regional African markets. The 2013 Agoa Forum actually took place in Ethiopia. After this meeting, in mid-August, apparel retailer H&M, announced that it would begin sourcing clothing from Ethiopia for the first time.

H&M’s decision reflects a second trend benefitting Ethiopia: relative political stability and increasingly credible regulatory oversight. H&M’s largest sourcing market is Bangladesh, where the manufacturing sector has been hit by safety concerns and negative  publicity after recent garment factory tragedies brought the hazards of poor safety precautions to light. In response, some retailers have begun to look for sourcing locations with more reliable enforcement of safety standards, increasingly paying attention to metrics such as accountability, corruption, violence, and political and economic stability when selecting sourcing countries.

In addition to its stable environment, Ethiopia’s economic performance is fuelling interest in its manufacturing potential.  While per capita GDP remains low in actual terms, the country has posted sustained economic growth at an average of 11.3 percent for the last seven years.

This growth comes, in part, from a reform-minded government keen to unlock capital flows; a third factor priming Ethiopia for further FDI. Government officials are selectively opening sectors of the economy to investment, and are enacting policies to improve infrastructure, transport, and ease of doing business - typical barriers to manufacturing in Africa.

Though landlocked Ethiopia is closer to Western consumers than Asian competitors, transport costs have historically been prohibitively high. The cost to truck a standard container 340 miles from the port in Djibouti to Addis Ababa equals the cost to ship the same container 3,100 miles from Guangzhou, China to Djibouti. Recent and upcoming logistics reforms aim to streamline customs and transport processes. Those include an ‘Authorized Operator Program’ to expedite regular exporters, four more dry ports for faster clearance, and privatised management of the port in Djibouti – though how quickly progress can be made remains to be seen.

Public-private partnerships have also created several new industrial zones. The first, Bole Lemi, opened in March 2013 and is targeting Asian investment in leather and footwear. The Ethio-China Light Manufacturing Special Economic Zone in Lebu, on the outskirts of Addis Ababa, aims to eventually employ 100,000 workers and provide housing and schooling on site. Initial funding for Lebu came from Huajian Group, a Chinese leather shoe manufacturer, and interested investors include The China-Africa Development Fund and the International Finance Corporation. The zone is projected to require $2bn investment and yield $4bn return over 10 years.

Which brings us full circle to the final factor: wages and other costs. According to recent research by Dalberg, the management consultancy, Ethiopia’s labour costs – even accounting for lower productivity – are less than  66 percent of Chinese wages. Additionally, utility and land costs are low, bolstered by significant government investments in hydropower. Efforts to build the $5bn Grand Ethiopian Millennium Dam began in 2011. The project has hit funding hurdles and sparked controversy among environmentalists and neighboring countries – but if completed, it will be largest hydroelectric power plant in Africa, with capacity to export energy to neighboring countries including Djibouti, Sudan, and Kenya.

Payback

Profit forecast scenarios suggest the Ethiopian market is a viable one. A garment assembly factory with yearly output of 25-30m units would require approximately $5m in upfront investment, with payoff in five years and an estimated rate of return over 10 years of 25 percent. A $4m investment in a leather shoe factory has an estimated simple payback of three years and an internal rate of return of approximately 30 percent after 10 years. Similar opportunities exist in leather gloves, leather shoes, cotton textiles, and fresh fruit and vegetable production. While our analysis and other studies show that production cost of certain items are lower in Ethiopia, landed cost (factoring in transportation and other potential costs) may be higher.

For any of this manufacturing potential to be tapped companies will have to invest in training and technology transfer. Nonetheless, recent trends suggest that for forward-looking investors willing to bring industry expertise – winds are blowing in favour of manufacturing in the cradle of mankind. And companies from China – the 21st century’s leader in manufacturing – have already taken steps to be among the first to respond to the winds of change.

Paul Callan is global operating partner and Sanchali Pal is a consultant at Dalberg Global Development Advisors.
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