Following China's accession to the WTO in 2001, supply chains are on the edge of spectacular change, says Robert J Easton of Accenture.
The Chinese government is committing large sums of money to modernise the country's logistics and transport infrastructure. Local and foreign providers of supply chain services are rushing to upgrade their capabilities. Shippers and manufacturers are working to develop new and better supply chain capabilities that will help them provide better service at less cost. New players are entering the fray in a scramble analogous to the gold rushes of the past.
These changes are highly welcome and long overdue. China has perpetually been hampered by: poor infrastructure; a fragmented and chaotic distribution system; local protectionism; a lack of third-party capabilities; problems with cash flow and accounts receivable; and anachronistic and restrictive laws. These conditions mean there are few efficient supply chains in China, and that improvement in these areas will take time. However sustained growth, favourable government policies and entry to the World Trade Organization (see page 19) will drive significant changes in the supply chain landscape over the next five to 10 years.
THE STATUS OF SUPPLY CHAIN MANAGEMENT WILL RISE Since the government and businesses now recognise the immensity and impact of the country's supply chain performance gap – and for the first time are in a position to do something about it – status quo performance will no longer be acceptable.
DELAYS SHOULD BE ANTICIPATED China's presence in the WTO will result in major changes to China's economy, but transition delays will be unavoidable. However, the depth and duration of those delays will depend on how liberally the government handles its distribution and logistics sector and, in a macro sense, how committed it is to exposing domestic players to open competition in a free market.
Most likely, China will manage the opening of the logistics and distribution sectors carefully, and in a way that maximises opportunities to pass management and operational expertise to local companies. The June 2002 Ministry of Foreign Trade and Economic Co-operation announcement that it would pilot foreign investment in China's logistics industry, with regulations and conditions, demonstrates that the government intends to carefully manage foreign competition. The government's objective is to give local logistics providers enough time to get stronger, so that they are in a better position to handle competition. It also wants foreign companies to regard local firms as attractive investment targets, and for foreign firms to partner with local providers rather than compete individually. As a result, foreign investors should expect China to enact new rules to regulate competition and bring order to the WTO transition.
Delays due to structural factors should also be anticipated. A highly fragmented market, complex and localised distribution networks, poor infrastructure and limited operational capabilities will make overhauling supply chains a challenge. Because old habits die hard, long delays should be expected in navigating the state and provincial bureaucracies, most of which will strive to maintain the old ways of doing business.
COMPETITION WILL INTENSIFY Many sectors exposed to foreign competition are consolidating rapidly. This is particularly true in the consumer goods industry, where significant consolidation has already occurred in the home appliance, television and beer sectors. In China's planned economy, even the smallest manufacturer has its own truck fleet and warehouses, which means a significant duplication of logistics assets. With consolidation comes the opportunity to eliminate unnecessary assets and create new levels of scale and efficiency.
CONSOLIDATION IN HONG KONG Pressured to increase margins, exert greater control over channels and reach deeper into China's interior, more Hong Kong-based traders will band together.
PORTS WILL BECOME MORE EFFICIENT Greater trade flows, more intense competition, increasing demands from shippers for better service and a rise in foreign investment will lead to changes in the port sector. Since the inefficiency of China's ports is perceived to be one of the biggest obstacles to global competitiveness, major involvement of foreign companies in infrastructure joint ventures is anticipated. Under WTO guidelines, foreign firms will be able to take a 49 per cent stake in shipping joint ventures and participate in port development projects.
INEFFICIENT THIRD PARTIES WILL BE BYPASSED Unless real value is evident, more and more established firms will avoid third parties, such as state import-export corporations and wholesalers. As a result, third-party providers will be forced to upgrade their capabilities to remain attractive outsourcing candidates. Inevitably, this means eliminating unnecessary layers of bureaucracy and non-value-adding participants. In the pharmaceutical industry, for example, multiple layers of distributors exist, but only one layer is expected to survive in the future. And consolidation in the retail industry already is leading to manufacturers selling direct to retailers – a trend that is likely to continue as online systems are implemented. The US computer manufacturer Dell, for example, has achieved price points 10-25 per cent lower than its foreign competitors by taking middlemen out of the supply chain. Dell can reach more than 300 cities in China within nine to 10 days, seven of which are attributed to delivery time.
DISTRIBUTION CHANNELS WILL NOT PROLIFERATE In the wake of China's accession to the WTO, will there be a mad rush by shippers to develop their own distribution channels and wholesale networks? Probably not, since eliminating wholesalers, relying on foreign logistic providers or bringing distribution in-house would be prohibitively costly and time-consuming. Time taken to establish a network could also lead to lost sales or mar- ket share, and distributors would be certain to react unfavourably to attempts by shippers to develop their own networks. Even after all WTO clauses take effect, establishing an independent, nationwide network will remain a dream for most foreign companies. Instead, the majority will continue to rely on local partners to reach outside major urban areas and into second-tier cities and remote regions.
Therefore, smart shippers will find creative ways to work with what exists today and make it better. For example, they will look for ways to de-layer multi-tiered wholesaler structures and build long-term strategic relationships with major distributors that already operate distribution and logistics networks. Concurrently, their relationships will be driven more by guaranteed high volumes to meet cost and service requirements, and by financial incentives to increase sales. They also will be aided by better information flows, which will bring more transparency to the supply chain, closer contact with customers and efficiencies that are visible to all supply chain participants.
INTEGRATION WILL BE WIDESPREAD Significant progress will be made in the integration, centralisation and rationalisation of supply chain functions, assets, infrastructure, people and operations. This trend will be fuelled by the removal of regulatory restrictions, rising customer demands for one-stop service and the recognition that significant cost savings are achievable. For example, by integrating and centralising its procurement, raw materials distribution and finished goods distribution functions (which were scattered across dozens of product centres), Haier, a local home appliance manufacturer, realised significant reductions in cost and assets, and major gains in service performance.
Given the potential benefits, a rise of supply chain shared services organisations across foreign and local companies in China appears imminent.
THIRD-PARTY LOGISTICS PROVIDERS WILL CONSOLIDATE The opportunity to incorporate wholly foreign-owned enterprises (WFOEs) within three years of WTO accession is significant. This should attract foreign firms to an industry that is projected to grow by more than 30 per cent annually for the next five years and is willing to invest in the infrastructure projects that are needed to create a modern, national logistics network.
Over the next three years, however, the entry of foreign providers as WFOEs will place great pressure on local distributors to develop competitive capabilities. Already, competition is intensifying in third-party logistics and many players are joining the fray, including: traditional Chinese logistics companies; new or emerging logistics companies; the internal logistics departments of Chinese companies such as Haier; and foreign service-providers such as DHL, FedEx, Maersk and Exel Logistics. This competition will force a consolidation of the fragmented Chinese logistics and distribution industry, just as it did in the US and Europe. As this occurs, acquisition opportunities will arise. However, the development of large foreign operators will be evolutionary rather than revolutionary, due to the regulatory constraints that will remain in place for the next three years.
MINISTRIES AND LOCAL COMPANIES WILL RESTRUCTURE WTO membership will provide Chinese consumers, customers and shippers with choice, and choice means more competition. For this reason, China's accession to the WTO will have a more profound effect on local Chinese companies than it will on China-based multinational corporations. There also will be strong impetus for entities such as the Ministry of Railways, state-owned enterprises and local firms to develop more efficient capabilities. The current thinking is that China has three to four years to restructure its companies and industries before foreign providers become a significant force.
Many local companies are already getting prepared. Sinotrans, for example, is positioning itself to become the first company in China to offer total transportation and logistics solutions for countrywide door-to-door services. Sinotrans has 3,000 trucks, 160 warehouses, 75 vessels, 77 rail sidings and 15 port terminals capable of loading direct to rail. It also has 47 domestic subsidiaries, 263 joint ventures and 29 enterprises overseas. Sinotrans is also working to upgrade its track-and-trace and vehicle management (GPS and OmniTracs) capabilities, and is developing sophisticated warehouse management systems, from companies such as MK Logistics, which can be applied to meet the needs of Chinese shippers.
Sinotrans is in a prime position to provide a one-stop service to its customers, but it is not the only entity with serious competitive aspirations:
Cosco, China Post and China Rail are in the process of transforming themselves into value-added, third-party logistics service providers. China Chengtong Group, a US$1.2bn logistics and metal distribution company, plans to become one of the top five logistics service providers in China through a process of acquisitions and alliances.
Emerging local companies, such as STAnda, EAS International Transportation and PG Logistics, are developing valueadded services. These groups have limited assets, but are focusing on the delivery of solutions and services that cover the full supply chain. They are also targeting MNCs as key clients, but have quite a way to go before they can offer the complete solutions that these organisations generally require. STAnda already has a network of 12 distribution centres covering 600 cities, and claims to be able to deliver goods to more than half of these cities within 72 hours.
New entrants to the third-party market have also emerged from the in-house distribution divisions of local manufacturers such as Haier, Qingdao Beer Group, Dongfeng Truck Group and Orient International Holdings. Haier, for example, determined that the fast-growing third-party logistics industry is much more attractive than the commoditised appliance industry. In partnership with China Post, Haier has become a third-party logistics provider for food companies, such as Nestlï¿½. Generally speaking, state-owned enterprises and local firms may be less capable in the short term, but they do have several advantages over foreign thirdparty providers, including a broad network and asset base, brand recognition, existing relationships with the Chinese government and the fact that most Chinese companies prefer to work with local businesses.
OUTSOURCING WILL GROW Shortages of talent and supply chain capabilities will force companies to rethink their approaches to building versus buying versus borrowing those capabilities and expertise. Outsourcing is underdeveloped and highly fragmented in China. According to the US investment bank Morgan Stanley, third-party logistics service providers currently have a penetration rate of only 2 per cent of China's overall logistics business, compared with 8 per cent in the US and 10 per cent in Europe. This is likely to change significantly over the next five to 10 years, as the result of:
An increase in multinational corporation operations, which will create more demand for third-party services. Local domestic companies will gradually accept the use of thirdparty logistics providers as they concentrate on their core business and reduce costs and incentives in the face of greater competition.
Pressure on Chinese companies to reduce costs and increase service. For example, Legend (China's leading information tech nology hardware and services company) and Haier believe that third-party providers will not be able to reduce costs and improve service or control any more effectively than their organisations currently do. Legend, however, has only been able to get its inventory days to 28 (compared with six achieved by Dell). As performance levels among competitors rise, companies such as Legend and Haier may need to put outsourcing back on their agendas.
Foreign companies that had been forced to develop hybrid logistics systems (because of regulations and a lack of third-party capabilities), are now seeking more sophisticated capabilities and national coverage. The case for broader outsourcing is strongly supported by a 2002 survey by Mercer Management which reported that, although only 18 per cent of shippers outsourced their inbound logistics, 43 per cent intended to do so within three years ('inbound outsourcing' was determined to be particularly attractive to the automotive, IT and telecoms sectors). For outbound logistics, 80 per cent of shippers planned to outsource within three years, compared with 40 per cent in 2002 (con sumer electronics, automotive, food and beverage, IT and telecoms sectors show the strongest interest in this area).
Admittedly, third-party providers will not be able to provide all of the broad supply chain capabilities required by the market. Based on experiences in the US and Europe, it is likely that a rise of alliances and joint ventures will occur, as the best organisations in China work together to build competitive supply chains. Today there are few international, standard, market-based capabilities to align with. Many companies therefore still see ownership of logistics assets as crucial to their strategy. In the next five to 10 years, however, these capabilities will clearly emerge. When this happens, service-based, rather than asset-based, logistics will grow.
INFORMATION WILL BE KING As in the rest of the world, successful logistics in China will be more a function of information flow than the physical movement of vehicles and consignments. Chinese companies currently have physical assets (often to excess), but they lack information and knowledge. In the short to medium term, a strategic stock of assets will still be necessary for foreign com panies to secure trust and ensure quality of service. But over the long term, local and foreign companies will focus on solutions that leverage information and assets.
INFORMATION TECHNOLOGY WILL BE MORE CRUCIAL THAN EVER Businesses seeking a superior supply chain will have to acquire supply chain technology to achieve optimal decisions, integration and end-to-end synchronisation. More and more, these will be implementations (business-driven and process-focused) rather than installations.
LAGGARDS WILL DIE Those companies that cannot or will not change – or those that opt to tinker rather than transform – will be left to wither on the vine.
This is an edited extract from the Accenture report On the Edge: the Changing Face of Supply Chain Management in China. Accenture is a leading management and technology services organisation. Robert J Easton is a partner in Accenture's Supply Chain Management service line responsible for supply chain services in Greater China and Korea. Based in Hong Kong, he can be reached at firstname.lastname@example.org.