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LOGISTICS & TRANSPORT2008China Business Handbook 2008

China’s logistics infrastructure is under-developed and inefficient compared with international standards. However, increasing levels of investment and growing competition promise to transform the face of a potentially huge market.  

AS CHINA’S ECONOMY grows, so does the demand for logistics services. In the first three quarters of 2007, fixed asset investment in the sector totaled US $126 bn, an increase of 19% on the same period in 2006. However, the overall quality and state of the industry is nowhere near the level it needs to be to support the growth of the economy.

The logistical challenges in China are an area of deep concern for both the central government and for companies that operate in China. The underdeveloped state of the industry is seen as a drag on China’s current growth and is commonly cited as a key hurdle for China in building a sustainable position as a global trading superpower. This is borne out by the fact that logistics costs as a proportion of GDP stand at around 19% roughly double the level found in more developed economies. Admittedly, China has a vast geography and economic development challenges are acute, but infrastructure lags other areas of development.

Inefficiency is caused by a host of factors, most notably the extremely fragmented nature of the logistics market. According to government forecasts, China’s total annual logistics spending in 2007 was expected to rise by 11% to more than RMB 4,230 bn (US $604 bn). This spending is spread among 700,000 different companies involved in a wide array of logistics-related businesses. No single enterprise controls more than 2% of the total market. Such fragmentation and the absence of economies of scale mean that fixed asset utilization rates are low. It is difficult to match cargo across regions, for example, and this often translates into empty return trips and ultimately higher costs, especially in the less developed western regions of the country.

Most firms operating in China are understandably wary of logistics providers that, in their experience, add little value and offer poor reliability and virtually no visibility. Furthermore, domestic firms in China have historically held a simplistic view of the role of logistics as providing nothing more than transportation services, and indeed only 1% of today’s registered logistics companies offer comprehensive value-added services. However, with foreign multinational logistics service providers entering the market and offering broader value-added services, which increasingly are being demanded by both local and foreign companies, the demand for higher levels of service and greater levels of competition is driving change in the industry. Nevertheless, a variety of obstacles stand in the way of a transformation of the logistics landscape in China.

Regional Fragmentation

Regionalism in China is quite pronounced, and nowhere is this more evident than in the logistics industry. There is no central governing body with jurisdiction over the transportation sector as a whole. For example, trucking companies are taxed and licensed based on the provincial areas where they pick up and deliver. If a carrier delivers to a certain province, it cannot pick up a load in that province unless it has the appropriate license. Regional authorities are keen to protect their own local interests and therefore impose their own local regulations, taxes and fees.

Regionalism also leads to much duplication of infrastructure investment, such as roads that serve the same areas, as well as to numerous restrictions on entry/exit and extra tolls levied on non-local vehicles. In some extreme cases, highways simply come to an abrupt end at provincial borders, forcing vehicles to transfer cargo to local logistics carriers and resulting in unnecessary handling that increases damage and shrinkage.

Another legacy of the planned-economy era is the large number of companies with their own fleets of trucks and warehouses. For these firms, switching to a foreign third-party logistic company (3PL) would mean this capital investment sitting idle and would require the painful lay-off of redundant staff. While such a restructuring would be a constructive and ultimately more efficient approach, its short-term costs are hard to implement.

Service Shortcomings

China’s current logistics environment is characterized by poor service, a lack of industry expertise and a low level of value-added services. On-time delivery rates are just 87 % and damage rates exceed 2%, both of which are far worse than developed country standards, which are well below 1%.

Another problem is that advance booking is needed, especially for rail freight, because the government gives priority to industrial inputs and state commodities such as coal and grain. On the rail line between Beijing and Shanghai, for instance, advance notice of one week is needed; this rises to 30-40 days for the Shanghai-Xinjiang route. Moreover, only 20% of trucks are containerized and the IT infrastructure necessary to track goods remains virtually non-existent.

China’s logistics infrastructure is governed by no fewer then six state agencies, in addition to provincial-level regulatory bodies: the State Domestic Trade Bureau, the Ministry of Communications, the Ministry of Railways, the Ministry of Commerce, the State Development Planning Commission and the Civil Aviation Administration of China. Exacerbating the problems of overlapping jurisdictions and ambiguous lines of command, there is also a lack of standards for the even enforcement of regulations.

The silver lining for China’s logistics industry is the central government’s recognition of the current situation and its determination to remedy it. This is most evident in its 10th and 11th five-year-plans (covering 2001-05 and 2006-10), which have stressed the development of the logistics industry so as to facilitate and foster continued economic growth.

Transportation costs currently make up as much as 55% of total logistics costs, with road transport comprising nearly two-thirds of that cost. The government has targeted improvements in infrastructure to reduce this expense. In the first three quarters of 2007, it invested US $95 bn in transportation, a year-on-year rise of more than 13%.

While these figures must be considered in the context of a rebound from the enormous neglect of physical infrastructure during much of the period from 1960 to 1990, this is still a substantial increase in investment. Furthermore, announcements made by the Ministry of Communications in 2005 that outline future multi-billion dollar investments in ports, inland waterways, shipping channels and highways are being implemented throughout the country.

Roads and Railways

Road transport dominates the logistics industry in China, but today’s road network needs to be improved to better connect the various regions of the country, if China is to realize its projected economic growth rate and facilitate urbanization in the western and northern regions. To address this issue, investment of some US $80 bn in expansion projects is expected by the conclusion of the central government’s 11th five-year plan in 2010, and over the next 30 years total investment is expected to exceed US $250 bn.

The government is expanding China’s expressway network to 85,000 km in an effort to connect all towns and cities with more than 200,000 people. From 1994 to 2004 national total highway length grew at 5.3% per annum. When the expansion is complete, residents in eastern provinces should be only 30 minutes from the nearest expressway, while most inland residents will be within an hour of a major expressway.

Historically, China has utilized rail primarily for government-related shipments such as military equipment and commodities such as coal. While the country’s rail density is among the lowest in the world, traffic density on the rail system is among the highest. In its 11th five-year plan, the central government planned to invest about US $8 bn a year by 2010 to expand its rail network and increase the number of railcars nationally.

The plan makes western areas a priority and aims to nearly double the regional rail network to 40,000 km by 2020. Recent projects include the Qinghai-Tibet railway and a US $30 bn high-speed link between Shanghai and Beijing, reducing today’s travel time of 11 hours to just five hours.

In addition to public investment in China’s rail system, the government has begun to relax restrictions on foreign investment in the under-utilized transport network. In May 2007, Beijing permitted a US $1.6 bn foreign investment by CMA CGM of France, Deutsche Bahn AG (Germany) and Zim Logistics (Israel) in the newly established China United International Rail Containers Co. This is the largest foreign investment to date in the country’s historically protected rail network.

Ports

In the first quarter of 2007, Shanghai port's throughput was 5.8 m TEU, which made it the world’s second largest container port, behind Singapore on 6.6 m TEU and ahead of Hong Kong (5.5 m TEU). Chinese ports occupied nine of the top 30 spots in container cargo volume worldwide in 2006. In that single year, investments in China’s sea ports totaled US $7.8 bn, spread over more than 160 construction projects. Shanghai’s new deepwater port at Yangshan is expected to become the world’s top container port by 2010. Infrastructure developments surrounding international trading hubs such as the Yangtze River Delta region demonstrate China’s commitment to becoming the global gold standard for international trade and logistics.

Aviation

China’s airfreight industry is the most liberal component of its transportation sector and the central government has been keen to focus on increasing the overall capacity and reach of the aviation industry. Some US $17.5 bn has been allocated for the construction of airports between 2005 and 2010. This covers the expansion of 71 airports, the relocation of 11 existing airports and the construction of 49 new facilities.

International Competition

China continues to reduce the operating restrictions that apply to foreign entities in support of the market development model it has perfected: allowing foreign firms to grow while nurturing domestic competitors that can learn best practices from established logistics companies and drive the rapid growth of the industry. 3PLs are partnering with state-owned enterprises in an effort to merge modern logistics practices with local customs, processes and knowledge.

With the opening up of the logistics sector and subsequent increase in wholly foreign-owned enterprises (WFOEs) instead of just joint ventures, an intensive period of consolidation took place in China’s logistics industry in 2007. Both foreign and local 3PLs and freight forwarders are attracted to logistics markets that are projected to reach US $28.8 trillion in cargo volume revenue by 2013, of which 3PLs will account for 6.3% of the value at US $1,812.9 bn. This compares with a 2006 3PL market share of 2.2% in a sector valued at only US $162.5 bn.

To encourage merger and acquisition activity, the central government has excluded logistics as one of the seven strategic industries in which it plans to increase regulatory oversight, thereby smoothing the way for moderate-sized acquisitions.

The central government wants to establish 15-20 globally competitive Chinese logistics firms, but it also realizes that for this to happen it must allow foreign competition to develop service offerings, drive competition and stimulate reforms.

Contributed By: Francis Bassolino (Managing Director) and Pilar Dieter (Director) at Alaris Consulting in Shanghai. Alaris is a management consulting firm focused on supply chain management and strategic sourcing. Contact: pilar_dieter@alaris.com.cn