Global Economics

Chinese Logistics: It's Upgrade Time


The industry may be growing at an impressive rate, but inefficiency still dogs it, which hurts the country's GDP

Getting cheap goods out has never seemed too much of a problem for the Chinese. The country has cemented its position as one of the central pillars of global trade by exporting staggering quantities of cheap manufactured goods, and is arguably now second to none as the economic hub of Asia.

Logistics provider FedEx Express certainly thinks so, judging by its plans to establish a US$150 million Asia Pacific hub in Guangzhou.

"In very practical terms, China is going to be at the center of our entire Asia network," said David Cunningham, the company's president for Asia Pacific.

China now accounts for 8% of global exports and recently overtook Japan as the world's third-largest country in terms of foreign trade volumes. Exports have more than doubled over the last five years and are expected to double again by 2010, accounting for 11% of the global total.

Rampant growth in logistics revenue points to an industry in good health. According to the China Federation of Logistics and Purchasing (CFLP), logistics industry revenue grew 20% in 2002, 27% in 2003, 30% in 2004 and 33% in 2005.

Viewed through a different lens, though, the picture changes. As volumes expand, cracks are being exposed.

The industry is still dogged by inefficiency, with CFLP figures showing that logistics costs accounted for 21.6% of GDP in 2004. Given that logistics costs come to 9% of US GDP and 11% of Japanese GDP, it could be argued that China wastes around one-tenth of its total GDP through logistical inefficiencies.

The sector is also stretched to the breaking point. The total handling capacity of China's coastal ports is already over one billion tons, and capacity is increasing quickly. But not quickly enough.

Speaking in January, Shen Yihua, vice director of the commerce ministry's Waterway Transport Planning Institute, said that China cannot expand port facilities quickly enough to meet rising demand. In 2005, the turnover capacity of coastal ports was officially 2.52 billion tons, but 3.38 billion tons were actually handled.

"In the next 10 years, the development of port construction should be faster than economic growth," he told state media.

Internally, logistics networks are even more stretched, creating problems as retailers and manufacturers look beyond the largest Chinese cities to those in the tier two and tier three categories.

Paradoxically, it is more difficult for manufacturers and retailers sourcing in China to reach inland markets than export to the rest of the world.

AMBITIONS FOR GROWTH

Despite this, both local and foreign retailers have big expansion plans. As retailing accounts for 75% of logistics activity, foreign logistics providers are moving away from their typical export-only remit to meet this growing domestic demand.

For all intents and purposes, the market is now open for wholly owned foreign enterprises, in accordance with China's WTO accession commitments. Overseas players no longer need to work with a local joint venture partner (See: Two's a crowd: Life outside of a JV) and so most now have a presence on the mainland.

But it is still not plain sailing, with a variety of regulatory-driven inefficiencies waiting to cling to those who come in.

David Oldridge, an associate at consultancy JHK Hong Kong, is all too familiar with these problems. He blames some of this on the logistics companies themselves, but says "institutionalised bureaucracy" is most responsible.

Motorola's problems are instructive. The company produces its mobile handsets through both a joint venture and a wholly-owned subsidiary. However, because the units have a different legal status, Motorola must use separate distribution channels to meet duty, tax and other bureaucratic processes, preventing cost savings through economies of scale.

SCENIC ROUTE

It is also often cheaper for a provider trying to move goods between two provinces, or even within a province, to export the goods to Hong Kong and then back into China, even though it is less efficient in time and actual shipping costs.

For example, a company that manufactures a component in Zhuhai for incorporation into a product made in Dongguan - two cities on either side of the Pearl River Delta - will ship the goods via Hong Kong rather than directly.

Just passing through Zhuhai customs can trigger an immediate 17.5% value-added tax (VAT) rebate.

"If they went directly from Zhuhai to Dongguan and then the finished product was exported from there, the original company has to wait for a daisy chain of events to occur before they can claim back the VAT tax," said Oldbridge.

"The cost per tonne per train or per ship is not so expensive - it is the convoluted process that drives the cost up."

Another problem is that up to five government organizations are involved in the logistics function in China, many of which operate on a provincial level.

"I guess in any country those types of processes can be streamlined," said Jaime Bolton, Greater China and North Asia supply chain management lead for consultancy Accenture. "If you look at the facts and you see that logistics is double the cost of elsewhere, I think there are certainly opportunities for streamlining."

The government is moving in the right direction with legislative reform, said Mark Millar, honorary chairman of the China Supply Chain Council, but differences in the interpretation and enforcement of rules between different regional customs authorities slows the process.

For Christophe Vincent, general manager of Dachser Shanghai, a wholly foreign-owned logistics company, it is these regional variations that cause the biggest headaches. But they are not insurmountable, he stresses, provided you understand how the different systems work.

"We have the usual administrative delays which are still happening, but as long as you incorporate these in your business plan you don't see it as a drawback. It goes with the China way of doing business."

Incorporating delays into a business plan may work, but those shipping goods, and their clients, have to meet the costs.

Competition between local jurisdictions is also a complicating factor. Many local authorities won't let trucks from other provinces cross the border, requiring unnecessary unloading and reloading.

In other areas, the truck can cross, but the drivers must be changed.

Toll fees are usually about 20% of total transport costs and many operators meet tight profit margins by dodging these fees. They do this by overloading, slowing deliveries and increasing the damage rate of goods by taking sub-standard roads. Savings are not passed on to customers.

Regional protectionism has contributed to great fragmentation in the industry. The CFLP says there are now more than 700,000 logistics enterprises registered in China, mostly small and medium-sized operators. Even the largest logistics providers have less than 2% market share.

Most of them lack strategic planning, trained personnel and systematic management. They tend to operate on a local or regional level, meaning supply chains must rely on multiple service providers.

For example, Wal-Mart needs some 15,000 suppliers to service its 60 or so stores in China. In America, it services 3,800 stores with only 61,000.

Meanwhile fashion label Liz Claiborne has to manage an army of third party logistics suppliers (3PLs), integrators and freight forwarders used to link its factories to its regional distribution hubs throughout China and on to its offshore retail operations.

The dream for most retailers and manufacturers is to be able to rely on one or a handful of logistics providers.

"It is very difficult for anybody to do that," said Oldridge. "Most of us can do some of it but nobody seems to be able to do everything yet."

While this is a problem for manufacturers and retailers, it presents a prime opportunity for logistics operators. Those who can offer integrated services will be in the ascendancy and this is expected to drive consolidation in the market.

This is likely to result in the industry being dominated by a handful of big companies, offering a full range of services and geographic locations. They will be supported by niche operators in highly specialized areas such as medical supplies and a few smaller regional players.

"I don't think there will be much in between," said Millar. "The people in the middle should either look to consolidate together to compete with the big ones, develop a niche, or get bought."

APPROACHING MATURITY

There are signs that consolidation is already taking place. In January, Qingdao-based SITC Maritime, China's largest private shipper, merged with Beijing's New Times International Transport Service, the biggest airfreight forwarder in export terms, to form SITC Logistics, with assets valued at US$127.7 million.

In addition, around 15,000 domestic logistics companies have listed themselves on various databases as available for acquisition, said Millar.

Takeovers are playing a key role in the expansion of foreign players. TNT China is pressing ahead in its acquisition of China's leading freight and parcels transportation operator, Heilongjiang-based Hoau Logistics Group.

Adding Hoau's 1,100 depots and 56 hubs across all tier one and tier two cities to TNT's existing web of 25 wholly owned operating branches and presence in over 500 cities, will turn the company into China's largest private transportation network for freight and parcels.

Many of those looking to enter the Chinese market see the inefficiencies in the system as a way of improving on the tight margins competition has forced them to accept in their home markets.

In Oldridge's view, this may be wishful thinking. Western transport companies are lean, but they depend on modern infrastructure and smooth regulation. The same inefficiencies that plague domestic operators will also affect new entrants.

"Put someone on the Tianjin to Beijing road and try and do what we do between Melbourne and Sydney," he said. "It's just not going to happen. Every morning when the fog comes along, someone kills themselves and the road shuts down for eight hours."

INTEGRATED SOLUTIONS

The advantage foreign entrants have is experience in offering an end-to-end supply chain management system. These integrated services are where big savings can be made and it is an area that domestic firms have so far been unable to crack.

Again, Oldridge blames this on an excessively bureaucratic infrastructure but he believes the situation is changing rapidly as more savvy domestic operators emerge. The window of opportunity for foreign entrants is narrow.

"The overseas investment has to get a return very quickly because it won't be long before the competitive edge is eroded," he said. "You can bring modern technology and processes into third world countries, you can export 25 years of knowledge and know-how - but it takes about 25 minutes to copy it."


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