A Roadmap to China's Logistics Landscape
China’s logistics landscape is a patchwork of astonishingprogress and infuriating roadblocks. Smart shippers and logistics providers know what to work with and what to avoid. A new research report helps the rest of us.
By John Kerr -- Logistics Management, 1/1/2007
Just before Christmas, somewhere in Tianjin or Chongqing or almost any other major city in China for that matter, a truck was being loaded with parts destined for a factory elsewhere in the country. The factory managers worried about when the goods would arrive. They knew how much red tape they would have to wade through to get the parts they needed.
But there’s one thing the managers almost certainly were not fretting about. They were not waiting to hear what U.S. Treasury Secretary Henry Paulson—in Beijing that December day to voice concerns about China’s currency-exchange rate—had to say about the value of the yuan.
Somewhere between the spacious staterooms hosting Paulson’s delegation and the drab commercial buildings found in most of China’s cities, a super-economy is boiling. Summed up in recent headlines such as “China growth forecasts rise again,” it is an economy fired by unprecedented opportunities to make money. The treasury secretary’s visit was intended to help regulate that heat, and thus turn down the political heat generated by China’s huge trade surplus with the U.S.
Yet if anything is likely to crimp China’s growth, it will be logistics bottlenecks, not political pressure. Freight transportation can be downright primitive by global standards; there’s a fair chance that the truck in Tianjin was loaded by hand, that its driver had to pay off a low-level government official somewhere along the road, and that the condition of the road itself made for unpredictable delivery.
According to China Logistics 2006, the latest report from U.K.-based research firm Transport Intelligence (TI), it has long been understood that if China’s economy is to maintain its momentum, its logistics costs—currently up to three times the level of those in developed countries—must come down. Nobody who has seen first-hand the pace of road-building and port construction around a coastal metropolis such as Shanghai doubts that enormous effort is being applied to bring logistics operations in line with those of the developed world. But it simply isn’t enough, particularly as growth corridors begin to extend westward up the Yangtze River and toward inland manufacturing hubs like Chongqing.
WHAT’S CHANGING FASTEST?
Much has been written about China’s transportation resources and its logistics capabilities, including problem areas and investments. But what is changing fastest? And what is barely changing? China Logistics 2006 provides intriguing answers. Let’s look first at where logistics sectors are especially vibrant:
Air freight: Although China’s airfreight sector is constrained by inadequate infrastructure, its development has been rapid. TI projects annual growth of 10 to 15 percent (assuming that road and rail remain substandard), with much higher growth rates for services catering to high-value products such as electronics and pharmaceuticals.
China also boasts the second-largest domestic airfreight market in the world after the United States. According to Boeing’s World Air Cargo Forecast, the market has grown at more than 20 percent annually since 1991.
Airports are seeing rapid expansion in three principal economic areas: the Yangtze River Delta (YRD), the Pearl River Delta (PRD), and the capital city of Beijing. Expansion in the PRD is so significant that it threatens to cut into the volumes handled by Hong Kong, the world’s largest air cargo airport. But a large proportion of the goods exported from South China are routed through Hong Kong. Its position has been strengthened, moreover, by an agreement that allows Chinese airlines to expand their international services via Hong Kong and gives Hong Kong airlines greater access to the mainland.
So who has the upper hand in the air cargo sector? “It’s the major players who will stand to benefit,” notes John Manners-Bell, CEO of TI. FedEx and UPS are both big operators in China. FedEx, for example, has its own hub in Guangzhou, and UPS runs a Shanghai hub.
The undisputed giant, though, is Hong Kong-based Cathay Pacific. Cathay has huge international freighting capacity. That and its recent acquisition of rival Dragonair, puts it in pole position to dominate the market at the expense of other large players.
The Dragonair deal is only part of a broader consolidation trend in China’s airfreight sector. In 2006, Air China Cargo Co. Ltd. and China Cargo Airlines Ltd. agreed to merge. The new Shanghai-based company, China Cargo Airline Ltd., will be a 50-50 venture between Air China and China Eastern.
Express package: China’s express parcel industry has changed out of all recognition. Growth is running at nearly 40 percent compounded annually. Now permitted to buy domestic companies outright, UPS and FedEx have already done so. (UPS acquired the rest of its venture with Sinotrans while FedEx bought its joint venture from DTW.)
However, there are risks involved in this strategy—not least of which is the difficulty of owning and operating assets in China’s domestic market. Time will tell if the joint-venture approach preferred by DHL (which partners with Sinotrans) works out better. DHL plans to invest about $215 million in express centers, new branches, express logistics centers, and strategic spare-parts centers.
Whatever the outcome in the express sector, it’s clear that the arrival of foreign players has stirred up domestic competition—for better and for worse.
Logistics outsourcing: The big change here is the widespread recognition of the capabilities of China’s homegrown companies for domestic logistics work. TI’s survey of logistics providers and users bears this out. “We asked Western manufacturers and retailers for their perspectives on using Chinese logistics providers,” says Manners-Bell. “We assumed they would use a multinational provider, but they were far more willing to look at Chinese firms.” Almost half of respondents said they would be likely or very likely to outsource to Chinese companies in the next five years (see Figure 1).
Most of China’s third party logistics providers (3PL) are clustered in the three main economic regions. The sector remains heavily dominated by state-owned enterprises (SOEs) such as COSCO and Sinotrans. Large SOEs will seek partnerships with foreign-owned companies, but privately held operators, with their reputations for agility, flexibility, entrepreneurial capabilities, and IT know-how, are more likely to become acquisition targets. (For a list of some Chinese 3PLs, see “Local Names to Know” at www.logisticsmgmt.com.)
WHAT’S BARELY CHANGING?
Unfortunately, much of China’s logistics landscape remains oversubscribed and clogged with inefficiencies. On top of that come cultural hurdles—corruption remains endemic, and red tape is as thick as ever. Here’s a closer look:
Rail: Rail was the main form of transportation under the old communist model, but it has not adapted to the new Chinese economy, says TI. It is primarily geared to moving bulk commodities long distances. In theory, it should also have strong capability to move containers from ports to inland cities. But it is a gross understatement to say that China’s railroads have a chronic lack of capacity; they would need to double capacity just to cope with current demand.
Major investments are under way and more are planned. According to China Logistics 2006, the Chinese government’s long-term objective is to expand the network to around 100,000 kilometers—three times the current rate of track-laying—during the next five-year plan. The quality of infrastructure will also have to be improved; only 30 percent of the system is electrified today.
Privatization may help. State-owned freight forwarders such as Sinotrans and COSCO have the potential to develop more sophisticated, pan-China services, particularly through joint ventures.
Roads: Think “pothole.” Until the late '90s, much of China was served by the most rudimentary road system. The best network was concentrated around coastal cities, and even here roads were variable in quality. From 2004, there has been vast investment in road-building, but if anything, the bias toward the eastern coastal cities has increased, observes TI.
The development of pan-China road services is also limited by the many internal barriers to movement imposed by local governments, a situation that magnifies the economic isolation of one region from each other. Internal customs and policing barriers often favor certain transport activities and organizations.
Since 1996, about two-thirds of government expenditure on infrastructure has been invested in the road network. The program is scheduled to last until 2015, when the network should reach about 35,000 km of toll highways. Private-sector participation is being increasingly sought for road construction. But the needs will continue to outpace the road network’s capacity for years.
Bureaucracy: The Chinese transportation and logistics market is one of the most highly regulated in the world, according to TI. However, it is slowly opening up to outside competition, and this process has been facilitated by China’s 2001 accession to the World Trade Organization. By acceding, China committed to a timetable of liberalization for various industry sectors. For example, the limits on foreign equity in road haulage, warehousing, and similar services were abolished at the end of 2005.
TI notes that in addition to the regulations that control foreign access to the Chinese market, there are other controls that constrain both foreign and domestic operators. For example, the number of freight trucks is controlled through a permit system. Permits are awarded by local or regional authorities, and restrictions are imposed on carriers from outside of the region. In addition, there are myriad regulatory bodies, including China’s Ministry of Communications, the Ministry of Foreign Trade, and the China State Post Bureau. Thus, getting the green light for any logistics project in China still relies heavily on the strength of contacts within China’s bureaucracy.
MORE TO COME
Of course, there is much more to China’s fast-paced logistics story. Just one angle: Skills shortages remain particularly challenging for Western managers. “Demand for trained employees will only rocket,” says TI’s Manners-Bell. “But there are still weaknesses in how people in China are taught. They may know a lot about an industry, but a lot of it will be learning by rote. There are not a lot of analytical skills,” he adds.
But for all its challenges, the China story is one that more and more U.S. and European managers are finding that they simply cannot ignore. No doubt there will be other trade and political delegations to petition for concessions on exchange rates or greenhouse-gas controls. But as long as there is a yuan to be made, the trucks will keep rolling, however slowly and inefficiently, all across China.
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