In the past decade, manufacturing in Vietnam has been at the epicenter of the country’s high growth. This sector contributed more than 20 percent to the country’s GDP1 and has been an anchor in Vietnam’s trade balance, helping to attract foreign direct investment (FDI). It played a significant role in the remarkable resilience that Vietnam’s economy demonstrated in the face of global upheaval, which maintained a positive GDP growth rate of 2.6 percent in 2021, even amid the COVID-19 pandemic, and sustained an 8 percent growth rate in 2022.2 This resilience is also a testament to the country’s robust control measures and strategic economic planning.
A unique combination of several key advantages has made Vietnam a prime destination for international investment, especially in labor-intensive manufacturing—these include the relatively low cost of labor, appropriate infrastructure to support export, and Vietnam’s strategic location, sitting on major trade routes.3Recovering from the pandemic, Vietnam must position itself for recovery,” McKinsey, July 1, 2020. Government measures at national or provincial levels, such as corporate income tax breaks for high-tech companies or specific fit-for-purpose industrial zones, have also helped.
Vietnam continues to be an attractive location for supply chain diversification. Its status is supported by the trade benefits that the government has established in recent years: besides being a member of the World Trade Organization and Association of Southeast Asian Nations, Vietnam has entered into 15 free trade agreements with partners across all continents, including strategically important partnerships such as the EU–Vietnam Free Trade Agreement and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, all favoring lower trade tariffs to boost trade value.4
However, 2023 brings its fair share of challenges and opportunities. Inflation, geopolitical complications, a gloomy economic outlook for several of Vietnam’s trading partners, and technological advancements that all manufacturing locations have to keep up with mean that Vietnam’s strength in providing low-cost labor may not have as much of an edge as before.
Reduced demand from Vietnam’s key trade partners and tightened monetary policies have also affected this Asian rising “tiger.” The export of goods for the first five months of 2023, for instance, declined by 12.3 percent compared with the same period in the previous year.5 In addition, structural and deeper fundamental challenges call into question the ability of Vietnam to keep expanding its manufacturing base and attract investments. The sector currently faces four challenges.
The competitive advantage of Vietnam as a manufacturing destination is not likely to erode overnight, but the hiccups that surfaced in 2023 highlight the need to shift from being positioned as a cost-effective to a productive manufacturing destination. Efforts from stakeholders can focus on a single North Star—maximizing output per worker in the manufacturing sector. This would require an orchestrated collaboration between the public and private sectors. While Vietnam’s government has continually enabled such efforts, they need to be effectively cascaded down to the provincial and industrial-park level with simplified processes.
Meanwhile, the government has consistently set ambitious targets for the manufacturing sector. It is expected to contribute 30 percent to the overall GDP, of which high-tech products should compose at least 45 percent. The sector’s contribution to GDP should grow by more than 8.5 percent per annum, and labor productivity should grow 7.5 percent per annum.10 This ambition is not new—in fact, authorities have been focusing consistently on manufacturing for years, investing in infrastructure and facilitating foreign investment with that purpose.
Several conditions will need to happen at the same time to unlock progress toward this goal.11 These include prioritizing and promoting industrial upgrading in manufacturing subsectors where Vietnam has stronger competitive advantage. The government can also cultivate supporting industries by incubating businesses that have the potential to become the backbone of the manufacturing sector, such as spare parts, specialized supporting equipment, and software.
Upskilling the labor force is another factor. This should be a joint effort between the government, trade associations, industry leaders, and educational institutions. Based on best practices seen in other countries in the region, this multipronged approach is one of the most efficient ways to ensure that programs are relevant and practical. Finally, it could be worth exploring private investments to enhance productivity, which this article looks at in the next section.
For existing or prospective investors in Vietnam, one of the most top-of-mind questions is: how can they get the best out of their Vietnam operations? We believe manufacturers can still benefit from favorable labor competitiveness and, on top of that, apply different approaches to optimize their operations. Based on the current state of manufacturing in Vietnam, here are five domains that leaders can prioritize:
Use simple, proven digital tools and analytics solutions for process optimization. For a manufacturing landscape as labor-intensive as Vietnam’s, using data to inform decision making can help ease three perennial challenges: daily workforce attendance, above-average turnover, and skill mismatches. Even with the most basic efforts and investment, the upside to this can be significant. Depending on the current stage an organization is at and the business tasks that are most urgent, there are several domains that companies can consider:
This approach can have material results, even with moderate capital investment. For example, an electronics manufacturing company in Asia saw its productivity increase by 25 to 35 percent by eliminating the difference in workloads between workers’ left and right hands.
Selectively invest in upgrades for flexible automation. Beyond optimizing current processes to increase productivity, manufacturers can invest in automating physical manufacturing itself. In Vietnam, the business case for automation can be harder to make, as what one saves on labor might not be sufficient to warrant the capital expenditure needed to finance automation. How easily automation is adopted and how much return on investment it will reap may also be more complex to assess, given the varied levels of readiness and availability of such technologies among sectors and different steps across the value chains. For instance, adoption of robotics in production is more common among automotive producers and assemblers, as compared with garment and textiles producers. In another example, automating sewing in the apparel industry is considered relatively more challenging compared with other steps across the cut-make-trim process.
However, as labor costs rise and manufacturers increasingly compete on higher value-added products, the case for automation becomes easier to make. Coming back to the apparel industry as an example: it is estimated that 40 to 70 percent of labor time can be reduced through automation, which will make traditionally higher-cost locations—developed countries and their neighbors such as Mexico, Türkiye, and the United States—more cost-competitive. Mass-market apparel players are also shifting from a supply-push model, which favors low-cost outsourcing, to a demand-led sourcing and production model, which rewards speed and agility.
Once organizations have made automation their top priority, the biggest question they normally have to answer is, “Where?” Identifying the opportunities for automation that make economic sense for the organization requires companies to understand where they are in relation to regional and even global peers, given the highly integrated landscape of the supply chain, and build a simple business case that compares the value of productivity gains against the investment in automation.
Build supply chain resilience. Vulnerability in the supply chain has heavily impacted companies globally, and Vietnam was no exception, especially because it relies on imported materials for the production of key exports such as cell phones, computers, and electronics peripherals. Executives in Vietnam will need to work on two axes to improve this. On one hand, they can deploy digital tools for supply chain planning. These tools help to protect supply chains from disruptions by ensuring that the full chain is visible, stress-testing the supplier network regularly, and supporting decision making so that business continues smoothly even under pressure. For example, in the early stages of the pandemic, Nike accelerated its supply chain technology program throughout its outsourced manufacturing operations and its store network in China, which helped rein in its sales decline in the region to just 5 percent, much lower compared with its competitors.
On the other hand, developing an ecosystem of suppliers that are in Vietnam, or at least in Southeast Asia, can help reduce this vulnerability in the long run. Manufacturers in Vietnam can start considering nearshoring options, such as localizing some components of the supply chain, which sometimes requires strategic collaboration with authorities in manufacturing parks or provinces for long-term benefits.
Invest in upskilling talent. As manufacturers increasingly produce sophisticated end products, and as they implement process excellence, digitization, and automation, the need for skilled labor will increase. Finding, retaining, and developing top talent is therefore likely to become a strategic priority for local producers (Exhibit 3). To do so, companies need to develop onboarding and training journeys and strengthen their capability-building muscle. This often goes hand in hand with initiatives for process excellence and automation, as the teams in charge of the transformation also handle upskilling. Increasingly, those efforts can be combined with hybrid learning journeys that include digital modules, as well as on-the-job training, to be most impactful.
Strategize the transformation. Only about 20 percent of the organizations in our recent survey reported high levels of success in driving transformations. To succeed, transformation plans must meet three conditions: first, they need to be value-backed, meaning organizations should prioritize use cases that generate the most savings and which help create and sustain momentum in execution. Second, they need a structured implementation road map that is broadly communicated to stakeholders in the company to help break silos and that spans across strategy, talent, operating model, technology, data infrastructure, and analytics to enable adoption and effective scaling. Third, they need to be supported by a strict cadence of project review, measurement, and feedback loops to keep transformation plans on track.
Recent drops in FDI and exports in 2023 present an opportunity for Vietnam to rethink its position in the global context and act. The country is at a crossroads: it faces structural challenges yet continues to attract significant FDI that could fund a transition to a more productive manufacturing sector.
Matthieu Francois is a partner in McKinsey’s Ho Chi Minh City office, Thomas Hansmann is a partner in the Jakarta office, Bo Huang is an associate partner in the Singapore office, and Zoey Nguyen is an alumna of the Hanoi office.
The authors wish to thank Javier Del Pozo, Bruce Delteil, Julian Hügl, Azam Mohammad, Hien Pham, and Khang Tran for their contributions to the article.