China's growing pains

May 5, 2005
Call it growing pains if you want, but China's rapid rise as a sourcing and manufacturing center is not without its negative side. Logistics professionals

Call it growing pains if you want, but China's rapid rise as a sourcing and manufacturing center is not without its negative side. Logistics professionals around the globe are learning to cope with issues that affect the cost and efficiency of their companies' sourcing or manufacturing arrangements in China.

With China expected to dominate the manufacturing landscape for the near term at least, how the country faces problems of congestion, regulation and cost will determine the competitiveness of those companies using China as a major sourcing market.

A recent study by analyst firm Aberdeen Group notes that while 64% of respondents to a 2003 survey said they were doing business in Asia, the number of companies with revenues over $50 million having "activities in China" had grown to 90% in 2005. And most companies responding to the current survey expect overseas suppliers and overseas sourcing to continue to increase.

One startling result of the Aberdeen study is a reported 91% of respondents say they suffer unexpectedly higher costs and are challenged to respond to market demands. Those companies say their product cost savings are eroded by these unanticipated global supply chain costs.

Far from a lack of planning on the part of the companies using Asian — and specifically Chinese — sourcing, the problems that are eroding savings stem from core areas, some of which China is attempting to address. Among them:

  • Infrastructure development
  • Congestion at ports and industrial areas
  • Logistics management talent
  • Wage inflation among logistics professionals
  • Regulatory environment
  • Corruption

Though no one Logistics Today interviewed would go on record with specific examples of corruption, it is clear that this problem has grown with China's rise in world markets. Some of the problems are linked to the heavy regulatory environment that requires companies to obtain various permits and documents to operate in China.

Implied in the statements that it is important to know the right people is the need to "influence" those people. Having a Chinese partner to manage relationships in China seems to help, but with China's entry in the World Trade Organization, the central government has announced — at least internally — that corruption won't be tolerated. They've set the tolerance bar very low.

Corrupt practices that can be proven and result in a low financial benefit to the individual are punishable by a prison sentence. A prison sentence in the current climate will ruin a person's career even after the sentence has been served. No one will be willing to hire that person given the close scrutiny this is likely to invite. Corruption that amounts to even a few thousand dollars can result in a death sentence.

Given the U.S. Foreign Corrupt Practices Act and the Chinese government's attitude towards corruption, there is no room for error for U.S. companies. The issue is worth noting, but it is a problem that could be fading away, and there are other areas where logistics professionals need to focus attention.

The talent search in logistics has many sides. Finding good people is less of a problem than keeping them, says John Manners-Bell, CEO of market analyst firm Transport Intelligence. Though universities are turning out logistics talent, demand outstrips supply, he notes. Plus, these newly-minted logistics professionals have basic qualifications but lack experience.

Many logistics companies in China suffer from poaching, especially from new market entrants which, says Manners-Bell, "come in with an open checkbook."

Hu Huang, director of international logistics and customs compliance for Kichler Lighting, a U.S.-based manufacturer of decorative light fixtures, is also in charge of the company's China office. She has seen dramatic change over the years. Living standards in China are on the rise and mainland Chinese now visit Hong Kong as tourists with little risk that these waves of visitors will become a swell of economic migrants. The mainland Chinese have good jobs and good living spaces, says Huang, and they see Hong Kong as expensive.

Hong Kong's neighbor, Shenzhen, is one of the success stories. Growing rapidly as a special economic zone when Hong Kong was still independent from China, development continued even after Hong Kong reverted to Chinese rule in 1997. Shenzhen now looks like an extension of Hong Kong, says John Hafferty, vice president Europe and Asia for UPS Supply Chain Solutions, a third-party logistics provider (3PL).

Border issues are smoother between Hong Kong and Shenzhen and with mainland China — which used to represent three border crossings. Shenzhen had required special visas and identity cards for Chinese citizens working in Shenzhen, and it once maintained strict border policies with Hong Kong, which Hong Kong helped to enforce on fears of being flooded by economic migrants. Those borders now operate much smoother, says Hafferty, and cargo traffic moves quickly, in part because of the volume. Formerly restrictive border crossings have come to resemble the FAST lanes between the U.S. and Canada.

Huang agrees, adding that cargo moves from mainland Chinese factories directly to Hong Kong shipping yards, but unlike the U.S. border crossing under the North American Free Trade Agreement (NAFTA), they can use the same carrier and the same truck to reach the Hong Kong terminals. They don't have to stop and change vehicles or drivers as Mexican carriers do at the U.S. border.

While Huang feels the entry of U.S. and Western logistics companies into China is helping to teach logistics to the Chinese and to provide better systems, she sees Asian ports as far more efficient than in the U.S.

Productivity at Asian ports is three to four times higher than U.S. ports, says Huang. And, within China, some ports are better than others. Hong Kong, which the China Supply Chain Council describes as a value-added transit point, can still add time and cost, says Huang. Crossing a container to Hong Kong can take seven hours, she says, where the same process can be two or three hours at some of the newly developed ports in China. Also, truck fees to these ports are as much as 50% less than Hong Kong. Infrastructure is developing at China's port of Yan Tian and at Chiwan, says Huang. Yan Tian is helping to relieve some of the congestion at the port of Hong Kong, she points out.

Factory production and shipping capacity are both high quality and reasonably priced, says Brian Lutt, regional president Asia/Middle East for APL Logistics. Ports are continuing to grow capacity, but at a slower pace. The shipping network is also growing slower than is needed, he continues.

South China and Shanghai need deep draft. The river gives the port 27-29 feet of draft at high tide, says Lutt, but that's only sufficient for a containership to load about 1/3 of its capacity.

Shanghai, the world's third largest port, handled 14.55 million twenty-foot-equivalent units (TEUs) in 2004, up 29% over the prior year. Nearby Yangshan will be the world's largest with 50 berths and capacity to handle 25 million TEUs per year following an investment by the Shanghai government of approximately $12 billion.

ProLogis recently announced a joint venture with Lingang Economic Development Group to develop a 768 acre logistics park in Lingang New City, Shanghai. Phase one of the ProLogis Park Lingang will consist of eight facilities totaling nearly 1 million square feet. The park could support 15 million square feet of distribution space, according to ProLogis.

A 29 km (18 mile) bridge is being built to connect the mainland with Da Yang Shan and Hsiao Yang Shan islands, where as many as 90 container berths are planned. This will provide deep-water access, says Lutt, but all of the cargo traffic will have to move over the bridge or by barge to and from Nan Hwei County on the mainland side of the bridge.

Smaller shipping ports also provide feeder service to Hong Kong, Yan Tian and Chiwan, says Huang. All are located in the principal manufacturing area of China. Self-propelled barges can handle up to 120 TEUs, adds Lutt.

Landside infrastructure is also developing rapidly in South China and near developed areas like Shanghai. The first-tier area near the ports is seeing rapid growth. Efforts are also extending capabilities out to the second-tier areas that are developing manufacturing sites.

A "go west" initiative by the Chinese government has been attempting to push the benefits of development into a region that has seen little economic growth, but many of the resources — including qualified workers and infrastructure — lag behind the already developed or developing areas.

A research report by China's Integrated Transportation Research Development Center points to lack of infrastructure, differences in area development and a lack of general integration as critical gaps. China's regions are developing at different rates, according to the report, causing difficulty in integrating the transportation network and services.

Bureaucracy continues to plague companies operating in China. For forwarders and third parties entering the market, the Class A forwarding license everyone seeks is not enough, says Manners-Bell. There are licenses or permits from the Civil Aviation Authority, the Ministry of Commerce, Ministry of Communications and even a domestic transportation license for those companies like Exel which have elected to avoid the use of agents and bill customers directly.

Customs can also be very complex, adds Kichler Lighting's Huang. A manufacturing center like Dong Guan has as many as six different customs branches, she explains. Each customs station is unrelated, though they fall under a provincial customs authority.

If a logistics manager is trying to consolidate shipments from two suppliers in Dong Guan, you can find each manufacturer falls under a different customs branch. Those customs authorities are at the same level and they don't talk, so there can be a problem. Can it be resolved? Yes, says Huang, but this is an example of the bureaucracy shippers face in China.

The good news, Huang is quick to point out, is that customs reform has progressed. In the recent past, exporters had to take handwritten documentation and accompany their container to present the documents and have them stamped with a "chop" before moving the container to the port where another customs authority processed the shipment. Now, everything is direct electronic data interchange (EDI) at the major ports.

"Once you declare your goods at the first station, the information automatically comes to the second one," Huang observes.

Other barriers had included very limited hours when customs officials were available. In some ports, says Huang, Chinese customs opened at 9:00 a.m. and closed at 2:00 p.m. Now they operate eight hours a day, and some will adjust to the flow of trade and stay open longer hours.

Security is also less of a concern, according to Hafferty at UPS-SCS. More Chinese ports are joining the U.S. Container Security Initiative (CSI). But beyond that, the U.S. is clearly leading the way on security requirements, with Canada and the U.K. following that lead. The implication is that security issues will be aligned with U.S. requirements.

While large multi-national companies may manage their own logistics in China, many firms will opt for third-party logistics providers (3PLs) to negotiate the complex environment. In fact, 50% of logistics activity in 2005 was expected to be handled by 3PLs.

As recently as 1999, the 3PL segment in China accounted for $55.8 billion. To put that into perspective, the U.S. 3PL industry had revenues of $89.4 billion in 2004, according to Armstrong & Associates. This reflects a 14% compound annual growth rate since 1996, says Armstrong. A rough calculation places the 1999 China 3PL market at a point that the U.S. market reached a year later. China's 3PL market is expected to reach $120.8 billion within five years.

As efficiencies and logistics experience develop, China should be able to chip away at its current high logistics costs. Logistics accounts for 20% to 30% of the cost of goods in China, double the cost of developed nations.

"China is the key to the economic health of Asia now," says Manners-Bell. "China is keeping the U.S. economy going in some respects," he continues. It is important to Thailand, Indonesia, Japan, Korea and other Asian nations as well, and it is supplying Europe and the U.K. The congestion developing outside European ports like Rotterdam, Antwerp and Hamburg is also a result of increased imports from China.

Intra-Asian trade will be a significant driver for China, agree both Lutt and Hafferty. APL Logistics' Lutt notes that a North Asian ocean service connecting India, Sri Lanka and Singapore was oversubscribed when it was introduced two years ago and it remains overbooked.

"Many U.S. importers relying on China will need other options," says Lutt. Vietnam is one (he calls it "the rocket of Asia").

China's own consuming market is developing with the rise of a middle class, adds Hafferty. His group has also started developing networks for aftersales support in Asia as the intra-Asian market continues to grow.


Aberdeen Group
APL Logistics
China Supply Chain Council
Hong Kong Economic and Trade Office
Kichler Lighting
Transport Intelligence
UPS Supply Chain Solutions
U.S. Bureau of Customs and Border Protection