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China's Cold Chain: It Won't Fix Itself

At the China Cold Chain Summit held in Shanghai in July, an attendee casually commented that, despite the obvious need for quality improvements in pharmaceutical and food safety, logistics companies only stand to lose money with an investment in temperature-controlled services in China. The debate often heard around cold chain logistics in China centers on two issues: the high cost of temperature-controlled transport, storage and distribution, and the government’s ability to implement and evenly enforce regulations. To solve this wide-reaching cold chain problem, both of these issues must be addressed simultaneously. That is, Logistics Service Providers (LSPs) must be willing to invest in assets to supply temperature-controlled logistics, and China’s governments must demonstrate effective policy making and enforcement to ensure this investment is not wasted.

The Need for Investment

It is clear from both an international and domestic perspective, that China’s cold chain needs improvement. Internationally, China has a tarnished reputation that requires repair around the healthful manufacturing and handling of consumable products. Domestically, over 30% of China’s fresh food and vegetables is lost through poor transport and handling. China’s perishables are properly transported approximately 20% of the time, compared to over 80% in developed countries.

With such poor performance, the current supply of temperature-controlled conveyance and storage units is not sufficient to address the need and production levels of China. Less than 2% of the nationwide fleet of railcars in China is refrigerated. And as of 2005, only 30,000 refrigerated trucks were registered throughout the country, as opposed to 280,000 in the US and 120,000 in Japan.

Furthermore, the need for temperature-controlled distribution is not likely to subside in the future. Market projections forecast that by 2017, China’s growing middle class will spend ￥ 5 trillion RMB ($650 billion USD) on food. At the same time, mass urbanization is creating an increase in the Chinese consumption of frozen and chilled foods, resulting in a 10% annual increase in the production of such foods. The distribution network required to ensure safe and effective supply to this growing demand can only be supported by significant investment in the existing infrastructure. Major manufacturers, retailers and distributors need to bring the right assets on line.

Who Is Driving the Bus?

Despite forces that would seem to dictate the call for cold chain investment, companies are slow to act. Today’s demand for and, equally importantly, enforcement of, Chinese temperature-controlled storage, transport and distribution is primarily being driven and funded by multinational corporations (MNCs). They hold a higher standard of quality that calls for independent inspection and temperature monitoring of shipments. The logistics companies that service this demand have leveraged the annual shipping volumes to justify their investment in cold storage warehouse and transport facilities. With transportation accounting for up to 80% of the overall logistics cost in the cold chain, a LSP’s investment in cold transport assets would appear to be prohibitively expensive.

However, after the initial investment in refrigerated transport (approximately 40% higher than non-refrigerated trucks), the benefits of such an investment can be significant. An evaluation across Chinese cold chain service providers indicates that, at full utilization, a cold chain fleet has the potential to realize up to 84% greater monthly profit margins than a non-temperature-controlled fleet of the same size. As long as the MNCs continue to demand strict adherence to quality distribution standards, the LSPs that invest in the correct assets should continue to achieve a good return on their investment.

Table 1: Monthly Profit and Loss of Cold Chain Transportation in China

Fleet of ten 22 - ton trucks making nine 1800 km trips each month	Non - refrigerated transport	Refrigerated transport
Monthly Revenue	￥ 990,000	￥ 1,188,000
Monthly Expenses (Depreciation, operational, maintenance, taxes)	￥ 913,419	￥ 1,046,643
Monthly profit margin	￥ 76,581	￥ 141,357

 

Source: Alaris Analysis

 The Need for Enforcement

Though the benefits of a cold fleet seem enticing, LSPs, outside the MNC customer base, are not seeing enough of a demand and immediate willingness on the part of their shippers to pay for cold transport. The reason is that government regulations around the transport of perishables are too easy to circumvent. Currently, there is no comprehensive enforcement body that ensures perishable products are distributed in a safe manner. Although the standards are written, no consistent auditing is done, and, therefore, shippers feel no consequential penalties. Without this enforcement function, the standards are largely ignored.

This lack of enforcement puts LSPs that comply with stricter, global standards at a significant competitive disadvantage... Many local food distributors and retailers do not adhere to the current regulations and will not compensate LSPs for the added cost of temperature-controlled assets. Without this added compensation ─ and until they can be assured that their returns will justify the investment in valuable cold chain assets ─ LSPs will continue to sit on the sidelines. To ensure that their investment is not wasted, the majority of LSPs will wait until the government institutes a regulatory infrastructure that will guarantee increased demand.

Signs of Change

The scrutiny with which the international community is judging China’s ability to export safe consumable products is causing China to respond with direct and dramatic action. For example:

• In June, China closed 180 food factories as part of a nationwide crackdown in response to international concerns of China’s food safety after high levels of toxins and chemicals were found in exported products.
• Findings of corrupt policy enforcement in the approval of “fake drugs” by the Director of State Food and Drug Administration (SFDA), Zheng Xiaoyu, led to his execution in July.
• Under the Eleventh Five-Year Plan (2006-2010), the State Council issued the “National Food and Drug Safety” program that aims to establish a food safety guarantee system throughout China.
• In an effort to begin policy implementation at the provincial level, local governments have formulated a series of regulations and laws requiring perishable goods to be kept at specified low temperatures and not exceed recommended highest temperatures.

While such measures will help lay the foundation for a fairly regulated logistics infrastructure, a nationwide, uniform approach to cold chain policy needs to be in place for LSPs to make further investment in the requisite assets.

Enforcement Will Drive Investment

Indeed, local attention to the health and safety of the food and pharmaceutical consumer is at a record high, thanks to worldwide notoriety. At the same time, market projections indicate the consumer demand for a temperature-controlled distribution network will continue to grow. The question remains, however: “Who will be holding the bill at the end of the day for cold chain logistics in China?”

For LSPs to make an investment in China’s temperature-controlled storage, transport and distribution, they have to be able to achieve economies of scale among shippers willing to pay for the temperature-controlled quality assurance. However, neither will happen unless national and regional governments can mobilize quickly to implement formal and enforceable cold chain policies. Only then will the LSP community follow with this critical capital investment.

Source: Alaris Analysis

Jeff Bullard is Partner of Alaris Consulting in Illinois and Pilar M Dieter is Director at Alaris Consulting in Shanghai.