Sourcing & Manufacturing in Indonesia: An Introduction

March 29, 2022

Jakarta city center

 

Global supply chain disruptions have made companies aware of the importance of diversifying supply chains. As China focuses more on advanced manufacturing, companies target new markets for low-cost sourcing in Southeast Asia.

In this article, we review what makes Indonesia interesting as a supply market for foreign companies. We will cover its manufacturing industry, the benefits of choosing Indonesia for manufacturing, and the disadvantages.

Finally, we also review its free trade agreements and the most active regions and cities for manufacturing.

Indonesia Overview:

  • Population: 274 Million
  • Capital: Jakarta
  • Bordering countries: East Timor, Papua New Guinea, and Malaysia
  • Major cities: Jakarta, Surabaya, Medan, Bekasi, Bandung, Makassar

Indonesia’s Manufacturing Industry

Indonesia’s manufacturing sector contributes to more than 20% of its GDP, a significantly high level by global standards.

There are only five countries with manufacturing contributing to more than 20% of national GDP, including China, South Korea, Japan, Germany, and Indonesia. At the same time, the country still has relatively low exports of goods and services as a proportion of GDP.

This will change as exports are predicted to grow much in the coming years. The government has a goal to turn Indonesia into one of the top ten economies globally by 2030 and where manufacturing will be at its core.

Indonesia has traditionally exported much palm oil, petroleum, minerals, and coal. Other major industries now include garments and textiles, electronics, and automotive. Japanese companies have been particularly present in the market, investing in the automotive, electronics, energy, and mining sectors.

The automotive sector is considered important and contributes to more than 10% of the GDP, which speaks for itself. Since the 1970s, a fair share of Japanese brands have set up plants through local joint-ventures, including brands like Mitsubishi, Honda, and Toyota.

Investors should also be aware of Indonesia’s growing renewable energy sector, where we see much room for development. Renewable energy contributes to 12% of the national consumption, a number that is predicted to increase to 23% by 2025.

A challenge is to become less reliant on fossil fuels, which can hamper foreign investments if government goals cannot be met.

Benefits of Manufacturing in Indonesia

While companies have traditionally turned to China for manufacturing, increasingly more companies seek to diversify and target Southeast Asian markets. Indonesia is together with Vietnam and the Philippines the most interesting manufacturing destinations in Southeast Asia.

Below you can find the main reasons why foreign companies seek to enter the Indonesian market, both for manufacturing purposes or to profit from its growing middle-class.

Young and growing labor force

Indonesia has a population of around 275 million with a median age of 29.7 years. The population will continue to increase and the country will have the fifth biggest population globally by 2030.

At the same time, we see a high urbanization rate as young people move to bigger cities for job opportunities. Around 135 million are part of the workforce and that will continue to grow.

Low labor costs

Indonesia has the lowest labor costs in Southeast Asia, even outperforming Vietnam. While Vietnam has labor costs that are 1/3 of China’s, Indonesia’s labor costs are around 1/5 compared to China.

In addition to its large and young workforce, the low labor costs is one of the main perks for foreign companies who invest here. As mentioned in separate articles, we also have to consider productivity when comparing labor costs.

Productivity is still low in Indonesia compared to other ASEAN countries due to its low-tech contribution of manufactured products that are exported.

Growing domestic market

Foreign companies also eye Indonesia’s growing middle-class which will grow significantly in the coming years. It’s predicted that the middle class will increase by as many as 75 million people from 2020 to 2030.

E-Commerce and digital banking are two of the most promising areas with much room for growth. Early investors can benefit from a greater knowledge of the market and by building valuable networks locally.

Disadvantages of Manufacturing in Indonesia

It’s equally important that you know about the disadvantages of setting up manufacturing operations in a low-cost sourcing market. Below you can find some of the most outspoken disadvantages of choosing Indonesia as a supply market.

Infrastructure

Indonesia’s infrastructure is mediocre by global standards, something that hampers investments and growth. The president, Joko “Jokowi” Widodo, is sometimes even referred to as “The Infrastructure President” due to his generous goals to improve the infrastructure.

With an increasing population, urbanization, and industrialization during the past 20 years, we’ve seen great need for infrastructure improvements. From 2020 to 2024, the government aims to invest USD 430 billion in different infrastructure projects, which will benefit both local companies and foreign investors.

Bureaucracy and red tape

Indonesia is infamous for its bureaucracy and red tape that has kept investors on the sidelines. During the covid-pandemic, the country prevented USD 50 billion in fiscal support due to red tape, which speaks for itself.

Red tape is one of the main issues why Indonesia hasn’t climbed in the World Bank’s ease of doing business ranking. The issue is clearly addressed by the leadership and a priority to attract more foreign investors.

Free trade- and bilateral agreements

Free trade- and bilateral agreements are key selling points for low-cost country sourcing. The ongoing US and China trade war is pushing foreign companies to find alternative markets with lucrative trade agreements.

Vietnam is currently ahead among low-cost markets in Southeast Asia, having a free trade agreement with the EU (EVFTA), as well as a bilateral agreement with the US.

Indonesia has signed bilateral free agreements (FTAs) with Chile, Australia, Iceland, Liechtenstein, Norway, Switzerland, and Mozambique. Yet, it has only enforced its free trade agreement with Chile so far.

The country also negotiates free trade agreements with India, Turkey, the EU, and Tunisia.

Industrial Regions & Cities

Indonesia is as wide as the distance from Paris to Kabul and has 17,000 islands. Despite its large size, manufacturing is concentrated on the island of Java, where Jakarta is located.

Java is the home to 60% of Indonesia’s population and contributes to 58% of the country’s GDP. Most manufacturing activities can be found in West Java, Central Java, East Java, and Banten.

In this section, we review the provinces that contribute the most to Indonesia’s manufacturing output and what sets these apart.

Central Java

Central Java heavily relies on manufacturing and the sector contributes 30% of its GDP. The main industries are production of textiles and garments, accounting for 56% of investments. Other notable industries include non-metallic minerals, as well as wood and food processing.

The province has a developed infrastructure by national standards, having 11 seaports and 4 international airports.

Semarang is the biggest and financially most important city in the province, previously being a major seaport under Dutch rule. It has a strategic location for imports of products and labor costs are lower than in Jakarta.

The city will also benefit from foreign and domestic investments such as the Kendal Industrial Park. Also known as Park by the Bay, it’s a joint investment project with Singapore and will create as many as 100,000 jobs in Semarang and surrounding areas.

West Java

West Java enlaces Jakarta to the South and East and is one of the most economically active regions in Indonesia. 60% of Indonesia’s manufacturing activities can be found here, including textile production, automotive, machinery, and electronics.

It’s particularly interesting for companies who invest in plantations, livestock, and agriculture, thanks to its fertile soil. West Java accounts for 20% of the country’s rice production and 70% of the tea production.

Bekasi Regency, Bogor Regency, and Depok border Jakarta and are all important for domestic production and exports.

East Java

East Java might be located further away from Jakarta but still has great economic output, contributing to 15% of Indonesia’s GDP. The province is the home to the biggest shipbuilding yard nationally and has the biggest cement factory.

The provincial capital, Surabaya, has a significant economic value and has been one of the busiest and most important trading city ports in Asia since the early 1900s.

Manufacturing is concentrated around heavy equipment, shipbuilding, electronics, food processing and agriculture, and home furnishing.

Banten

Located to the West of Jakarta, Banten has a strategic position as it links the island of Sumatra with Jakarta. Being less developed and densely populated than the above-mentioned provinces, there’s much room for growth in Banten.

Tangerang City and South Tangerang City absorb much of the investments thanks to their proximity to Jakarta and more developed infrastructure. There’s better access to seaports, roads, education, electricity supply, and healthcare in the cities.

Banten has abundant mineral resources, including coal, phosphate, and gold, making mining one of its most important industries. The province also has notable manufacturing activities in the automotive, chemicals, and food- and beverage industries.

Summary

With a population of 275 million, Indonesia is the most populous country in Southeast Asia and with a workforce of around 135 million. With rapid urbanization and a median age of 29.7, the country is set to become a manufacturing hub in Asia in the coming years.

Its domestic market is expected to see great growth as disposable incomes increase and more people get access to smartphones, the internet, and modern financing options.

At the same time, the country struggles with infrastructure issues, red tape, and regulations that tend to be unclear and change frequently. To attract more investments, the country must become more transparent and ease the regulations for foreign investors.

As companies seek to diversify and become less reliant on China as a single sourcing market, countries like Indonesia and Vietnam will get more attention. This is particularly the case when China will shift from primarily being a low-cost sourcing market, focusing more on advanced manufacturing.

Indonesia has a bright future ahead, as long as it plays its cards right and makes the market more accessible.


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