Development of Logistics Industry in China

Development of Logistics Industry in China Chapter 1 Introduction 1.1 Background With the expansion of the globalization and the rapid development of the Information Technology (IT), the logistics industry has become one of the most important industries in the 21st century. The scope and role of logistics have changed dramatically over recent years. In the past, logistics played a supportive role to primary activities such as marketing and manufacturing. Now logistics has expanded from its traditional aspects: transportation and warehousing to purchasing, distribution, storage management, packaging, manufacturing and customer service. More importantly, the role of logistics has changed from cost absorbing to an important of competitive advantage for logistics companies. Modern theory of logistics in China was introduced in 1980s. Since its economic reformed and opened up in 1978, Chinas economy keeps booming, with a growth rate of nearly 10% in annual GDP which has become a global manufacturing centre. (Appendix 1) After China joined the World Trade Organization (WTO) in 2001, foreign companies were allowed to invest in China at the beginning but only in form of joint ventures that Chinese partner took up the majority. At the end of 2005, this restriction was completely phased out. At present, state-owned, private, and foreign logistics companies are all equally allowed to entry and compete in logistics industry in China. Chinas logistic industry has been experiencing fast growth because of sustainable economic growth. The logistics industry reported an annual growth rate of 31% in 1999, 35% in 2000, and 55% in 2001, and was expected to continue to expand rapidly in the future. (LI FUNG RESEARCH CENTRE, 2008) According to Exhibit 1, the average annual growth rate of the logistics industry in China was 22.2%, added value has reached to RMB 1.4 trillion in 2006 up 13.9% over 2005; and in 2007, the added value even reached to near 1.7 trillion up 20% over 2006. It is expected that Chinas logistics market value will continue to maintain an annual growth of 20% in 2010. Exhibit1: Total volume and growth of Chinas logistics industry 1.2 Total logistics market size The GDP of China was above RMB 10 trillion in 2002 that achieved a real growth of 8%. In the 10th Five-year Plan, China government is forecasting an average growth rate 7% per year from 2002-2007. According to the forecasts by State Development Planning Commission (SDPC), the GDP will be quadruple, about US$4.3 Trillion by 2020. In a detailed survey by the China Federation of Logistics and Purchasing (CFLP), the total logistics market was estimated at RMB1, 788 billion, 20% of the GDP in 2000. In 2002, it was estimated that the total logistics market of China were about RMB 2 trillion. According to HK Trade Development Council, leading logistics companies in China such as UPS, FedEx and DHL-Sinotrans have all recorded annual growths in over 30% on operations in China and there are more outsourcing contributes to the growth of professional logistics companies. 1.3 Players in the China Logistics Market Chinas logistics market is fragmented. Government registration shows there are about 700,000 logistics companies in China and many of them are small, poorly managed with fundamental infrastructure and technology. (Alan Dixon, 2008) Those of the players are lack of nationwide competences and customer target is narrow which mainly focus on simple transportation and warehousing activities. Competition is intense, especially in the low-end market. Traditionally, Chinas logistics market is dominated by the state-owned enterprises (SOEs) which provide 90% of the logistics services in China. 1.3.1 State-Owned Players There are many state-owned players in China logistics market. Before China joined WTO, Chinas logistics industry was a monopoly industry which could only be managed by state-owned enterprises (SOEs), mostly for transpiration and warehousing. The characteristics of the SOEs are small-scale local enterprises, slow product renovation, poor management, production plans following from various government agencies. Because of government investment and monopolistic operation, these enterprises obtained large assets and became relatively large-scale business organizations. Relying on their sufficiency capital and existing market share, these enterprises became leaders in China logistics industry at that time. The following is a list of SOEs that ranked top 5 in 2008 in China logistics industry: China Ocean Shipping (Group) Company (COSCO); China Railway Express Company Limited (CREC); China Post Logistics Company Limited (CPLC); China Railway Container Transport Company Limited (CRCTC). COSCO Logistics COSCO Logistics is a branch of China Ocean Shipping Company (COSCO) which was established in 2002. Because of the existing market share and advantaged infrastructure, it ranked number 1 in China logistics companies from 2002 to 2008. (Cen, 2005) COSCO Logistics has 300 logistics facilities, covering 90% of the China market and the competitive advantage is shipping transport. 1.3.2 Private Players Since the mid-1990s, Chinas private domestic logistics firms started to develop themselves such as St-Anda, PGL, China Overseas logistics and so on. The private logistics companies are in medium-size which keeps the rapid growth in the market because of achieving in efficiency and effectiveness and they are more focused on geographies, service and customers. But they are lack of sufficient financial supporting for market expansion and ineffective management to support high growth and profitability. (Fu. and Gwi, 2004) EAS International Transportation Ltd (Shanghai). This company was established in 1985. In the past twenty years, EAS has acquired tremendous achievement in building the unique operation platform to develop modern logistics business according to the demand of customers. 1.3.3 International Logistics Players (ILCs) Although the domestic companies dominate the general China logistics market, ILCs are also playing a very important role and their market shares are increasing rapidly. The most famous international logistics players in China are: DHL, TNT, UPS, FedEx and so on. DHL DHL entered China in 1981 and in 1986 it used joint venture with Sinotrans, one of the biggest SOEs in China logistics industry. DHL-Sinotrans has the biggest market shares in courier service. In the past twenty years, DHL has invested about $273 million in China. (Cen, 2005) Nowadays, many foreign logistics organizations have built good relationship with Chinese logistics companies by using joint ventures. Foreign companies have competitive advantage in technology and management, when they are integrated with experiences and existing service network of Chinese firms that they could be brought into full play. Therefore, Chinese logistics companies usually face Merge and acquisition (MA) risk. Many inland Chinese cities offer lots of commercial opportunities to foreign logistics companies but it need time for foreign companies to fully penetrate into the Chinese market. 1.3.4 Third Party Logistics companies (TPLs) Third Party Logistics companies (TPL) is a new concept for most of the Chinese companies. A TPL company normally provides process-base services rather than a function-base logistics service, which generally toward to the integration and fully control of a part or whole process of customers logistics network. (Fu. and Gwi, 2004) Because small or middle sized companies may not always achieve economics of scale in operating, which is even one of the advantages for third-party logistics companies. But due to the fundamental infrastructure of China logistics industry and developing technology, the TPLs are still need time to further improve the internal management in order to be expert in handling business. 1.4 Major modes of Transport in China After enter 21st century, the construction of transport infrastructure keeps rapidly increasing in China. 1.4.1 Ports Since China government opened ports to foreign investment companies in 2002, Chinese port facilities had taken huge steps that tremendous increased the capacity. In 2003, the total investment in Chinese port construction was US$2.2 billion, and in 2004, the Ministry of Communication has reported this figure was to reach nearly US$4.3 billion. Currently, Chinas coastal cities such as Dalian, Tianjin, Qingdao, Shanghai, Guangzhou and Shenzhen, which dominant regional logistics centres are completed new berths building. (Exhibit 2) In Shanghai for example, in 2003 the container throughput are 11.28 million Twenty-Foot Equivalent Units (TEUs) that is expected to increase to 14.5million TEUs in 2004 and in 2005, the TEUs of capacity has expanded 2M more. (Richard Brubaker ¼Ã…’2005) Although such huge investment and abroad expansion, Chinese ports need to keep up with the increasing demand by use foreign terminal operators more. Exhibit 2: Logistics hubs in China. Source: Beijing Readies Logistics Stimulus, 2008 1.4.2 Road China government heavy invests on China transport infrastructure, so the road transport becomes the prior choice for inland distribution. During the Five-year Plan from 2001 to 2005, transport infrastructure has been built significantly including 250,000 kilometers of highways and 24,700 kilometers of expressways. (Fu. and Gwi., 2004) By the end of 2006, the total length Chinese highway has reached 3,457,000 kilometers and 77,000 kilometers of railways. 1.4.3 Rail Compare with China road and port infrastructure, Chinas railway infrastructure has received relatively low levels of investment. The Ministry of Railways plans to increase Chinas existing rail network from 72,000 km to 100,000 km by 2020. (Woosir, 2009) Use of the Chinese rail system increased 6% year on year from 2003 to 2004, the modest increase is because the weak demand of rail transportation. There are many problems cause the weak demand for logistics companies, such as poor handling practices, delays, unpredictable delivery times, theft and a general lack of infrastructure. However, despite these issues exist, the heavy subsidization still makes Chinas railway become the cheapest transportation compare with shippers. 1.4.4 Inland Waterways The most significant Infrastructure on inland waterways is the Yangtze River, which increased 8% from 2003 to 2004. (Richard Brubaker ¼Ã…’2005) Yangtze River can handle ships up to 6000 tonnes totally, however, the capacity of canals and low bridges are relative in low level because of the dry season in China. There are many waterway projects such as Gorges Dam which can serve to extent dry seasons and keep water levels low. 1.4.5 Air freight Chinas airfreight sector is developed rapidly which has become the second-large domestics airfreight market in the world. According to Boeings World Air Cargo Forecast, the market has grown at more than 20 percent annually since 1991. (Richard Brubaker ¼Ã…’2005) The airports are fast developed by three economic zones: the Yangtze River Delta (YRD), the Pearl River Delta (PRD), and the capital city of Beijing. Moreover, the agreement between China mainland and Hong Kong gives Hong Kong airlines greater opportunities that access to the mainland. But the China airfreight is limited by insufficient infrastructure. In the coastal cities, the airfreights are more developed than that in inland cities. 1.5 Statement of the Problems Since China jointed WTO, the logistics industry developed rapidly. But there are lots of problems during the development; here the researcher mainly focuses on cost, productivity and expansion of China logistics industry. 1.5.1 High Cost Since China became one of the members in WTO, China logistics industry developed rapidly which kept high growth among all the industries. But the most important factor that slow down the development of China logistics industry is the high logistics cost. Chinas logistics expenditures took up 20% of the GDP in 2000 whereas logistics spending accounted for 10.3% of United Statess GDP, 14% of Japans GDP, and 10% to 13% of European Unions GGP. (Exhibit 3) The annual growth rate of total logistics expenditures is 10.29% in 2002, 12.99% in 2003, 16.76% in 2004 and 12.86% in 2005. (Song H. and Wang L., 2004) Statistics published by China Federation of Logistics and Purchasing shows that Chinas total logistics expenses reached RMB3.8414 trillion in 2006, up 13.5% year on year at current price, a growth 0.6 percentage points higher than in 2005. The rate of total logistics expense of GDP was 18.3%, 0.2 percentage points lower than in 2005. In 2007, the total logistics cost increased by 18.2% to 4540.6 billion yuan compare with 2006. Exhibit 3: Cost of moving and storing goods (as share of GDP). The total logistics cost in China generally includes three cost components: transportation, inventory storage and management cost. In 2004, the total cost amounted to US$ 352 billion, grew by 16.6% compare with 2005. Of this total, transportation cost took up the largest portion which accounted US$ 200 billion and had the highest growth rate which was 56.9% of total. On the other hand, inventory storage and management cost were US$ 102 billion and US$ 49 billion, accounting for 29.1% and 14% of the total logistics cost respectively (Exhibit 4). Exhibit 4: Total logistics cost and its composition, 2003-2007. Source: CFLP, 2007 Adding the costs of packing, transport, storage and damage cost, the ratio of total logistics costs to total industry production ranges from 40% to 60% in China logistics industry, whereas in the United States this percentage is close to 20% (Zhang Z.Y. and Andres M.F., 2006). So general speaking, the transportation costs in China logistics industry are twice as expensive as in developed countries such as US. Japan and European countries. 1.5.2 Low in productivity The ratio of total logistics cost to GDP represents the efficiency of logistics operation in the economy which means the productivity of logistics industry. It is also used as an indicator to the level of development in logistics industry. In general, the higher the percentage, the less efficient is the logistics industry. Exhibit 5 shows the total logistics cost as a percentage of GDP in the 10th Five-year Plan period (2000-2005) in China. Although the total logistics cost as a percentage of GDP has a downward trend that decreased from 19.4% in 2000 to 18.57% in 2005 and the total cost savings in the 10th Five-year Plan period are 109 billion RMB; according to exhibit 3, the logistics cost are higher than that in US, Japan and developed countries which means China logistics industry is still in high inefficiency. As predicted by the CFLP, the ratio of total logistics cost in China to GDP will continue higher which resulting inefficiency of modern logistics industry. CFLP predicted t hat total logistics costs during the 11th Five-year Program period (2006-2010) will grow at 10% annually, 2% higher than that of the 10th Five-year Plan period. It also forecasted that the total logistics cost will reach 5,400 billion RMB in 2010, the ratio of total logistics cost to GDP at around 16.8% and cost savings yield during the period will be around 435 billion RMB. (Ling Feng research centre, 2006) Exhibit 5: Total logistics cost as a percentage of GDP, 2000-2005. 1.5.3 Slowly expansion/outsourcing One of the most significant drivers of growth in the global logistics industry is the trend of mergers and acquisitions. Although many big China logistics companies have established overseas offices from the 1980s and 1990s to support their international transportation, their businesses are heavily depend on agents which means the Chinas global logistics network is still weak. For example, Sinotrans has business in nearly 200 countries, but there are only 40 overseas offices and most of the international businesses are done by the agents. In this situation, the expansion for China logistics industry is very slow. So, the global market share of China logistics industry is still relative low. As Contrill claimed, â€Å"dont expect a wave of Chinese 3PLs to land on Western shores soon. The pace of change in China is slow by Western standards and there is much to do in the home market†. (Cen Xuepin, 2005) 1.6 Research objective The objective of this research is twofold. To understand the development of China logistics industry in the last decade. To investigate the factors affecting the development of China logistics industry and recommend the solutions to improve on the problems to further develop logistics industry in China. On meeting the two objectives, this paper will develop a framework to address the factors that affect the development of China logistics industry. 1.7 Research questions Three questions will be discussed in this article: 1: Review the development of logistics industry in China in last decade? 2: What are the factors that affect the development of China logistics industry? 3: How to solve the current problems to further improve logistics industry in China? 1.8 Significance of study In this article, the author introduces the development of China logistics industry in last decade. Also, this paper will contribute by indicating and analyzing some of the problems that affect development of China logistics industry according to questionnaires and interview by managers in logistics companies in China. The theoretical framework is based on an extensive review of the hypothesis in literature review (Chapter 2) to ensure the main factors that affect development of China logistics industry. After that, the searcher will give readers recommendations that solve the problems in China logistics industry. 1.9 Limitations of the research Because of time restriction (from September to November, 2009), this thesis will be finished within 3 months, the research will cover the detail of logistics management (Transportation, Warehousing and IT supporting) as specific as possible. Because of the location of sampling in Shanghai, China, the researcher has to come to China but only around 1month, so it is time limited to the questionnaire distributing and receiving which may cause low response rate. There are many problems that influence the development of logistics industry in China; in this paper, the author only focus the above 5 main problems. Because some logistics companies are not public listed companies, it is difficult to find the data from the current annual reports released by these companies, so the researcher may analyze data in these companies using the previous annual report. (Eg: Annual Report of company A in 2006 or 2007) Some of the questions in questionnaires are directly related to the internal strategy of company management, so managers may do not want to answer which will cause the low response rate also. 1.10 Chapter Outline Chapter one Introduction: This provides the readers with background information of the study which creates a pictorial flow of the main research, research objectives, background of study, problems and significance as well as the limitations faced by the researcher are clearly stated in this chapter. Chapter two Literature review: This chapter explores relevant literature; it basically dealt with pertinent literature on problems of current China logistics industry with discussions on related research variables such as government policy and regulations, transportation cost, warehousing and storage, IT supporting and infrastructure. Also, 3 indicators to development of China logistics industry are given to be as dependent variable when analyzing the correlation with independent variables. Chapter three Methodology and Data collection: This chapter describes the research design used to conduct this research. This chapter will further disclose the ways used in analyzing data collected, limitations of the methods used and how the data are collected. This section concludes with discussions of the data gathering techniques and the data analysis procedures that are used to answer the hypotheses and research questions to readers. Also, theoretical framework is given to show the relationship between independent variables and dependent variables. Chapter four Results and discussions: This chapter outlines results of data analysis, provides discussion of research findings and builds bridges between objectives, findings and relevant literature. The result section summarizes the analysis of the data and present findings of the study with respect to the hypothesis and research questions, while the discussion section reviews the findings of the study in the context of the theoretical framework of the study. Chapter five Conclusions and recommendations are provided in this chapter together with discussions on the future of the study. This chapter concludes the research and documents the implications of the study with recommendations for future research. Chapter 2 Literature Review 2.1 Definition of logistics â€Å"Logistic† is the process of planning, implementing, and controlling the flow and storage of goods, services using related information from their point of origin to point of destination for the purpose of fulfilling customer requirements in efficient and effective way. (Raymond F. B. and Wm. B. M. Jr, pp: 45-55, 2004). Luo Wenping and Christopher Findlay (2002) said that the provision of logistics services requires inputs from a number of service providers; including the providers of transport and warehousing as well as other value-adding activities. Basically, logistic is business flow that connects packaging, distribution, storage and warehousing integrated Information Technology (IT) to transfer goods and service to the end users to satisfy their requirements. The concept of logistics has undergone many significant changes. Luo Wenping and Christopher Findlay, (2002) divided the development of logistics into three stages: Stage 1: Physical distribution or outbound logistics system (during 1960s and 1970s). Organizations attempted to systemically manage a set of interrelated activities including transportation, distribution, warehousing, finished goods, inventory levels, packaging, and materials handling to delivery finished goods to customers in efficient way. Stage 2: Integrated logistics management (during the 1970s and 1980s). Firms began to recognize the additional opportunities for savings by combining the inbound side (materials management) with the outbound side (physical distribution). Initially, this provided potential savings by having a single transportation manager who could coordinate inbound and outbound transportation. Companies also become aware of the opportunities to view the whole process, from raw materials to work-in-process inventory to finished goods, as well as managing the whole process from a systems perspective which could lead to more efficient operation. Stage 3: Supply Chain Management (from 1980s to 1990s). Logistics management is one of the parts of Supply Chain Management (SCM) that companies expanded their purpose on the logistics processes to include all the firms involved, making use of partnerships/alliances between manufacturing companies and their suppliers/vendors, customers (channels of distribution), and other related logistics parties such as transportation and public warehousing companies. 2.2 Third Party Logistics (TPLs) Third party logistics and related concepts are most often developed by researchers or consultants in collaboration with businesses demanding or offering third party services. Thus, the definitions reflect the phase of third party cooperation (Tage Skjoett-Larsen, 2000). Alessandra Marasco, (2008) used the following definition: â€Å"Third-party logistics involves the use of external companies to perform logistics functions that have traditionally been performed within an organization. The functions performed by the third party can encompass the entire logistics process or selected activities within that process†. According to this definition, third party logistics includes any form of externalization of logistics activities previously performed â€Å"in-house†. Through interviews with a number of North European third party service providers, Prabir K, B. and Helge V. (1996) have pointed out the following definition: â€Å"A logistics alliance indicates a close and long-term relationship between a customer and a provider encompassing the delivery of a wide array of logistics needs. In a logistics alliance, the parties ideally consider each other as partners. They collaborate in understanding and defining the customers logistics needs. Both partners participate in designing and developing logistics solutions and measuring performance. The goal of the relationship is to develop a win-win arrangement†. This definition emphasizes the strategic dimension of the concept and presupposes that several characteristics are fulfilled before the relationship between buyer and seller of logistics functions can be characterized as TPL. These characteristics include certain duration, joint efforts to develop further cooperation, a customerization of the solution, together with a fair sharing of benefits and risks. 2.3 Measurement the development of logistics industry Logistics has dramatically evolved from a supportive role characterized as passive and cost absorbing, to a primary role and critical factor in competitive advantage (Fu Chinchin and Gwi Ok Kim, 2004). Companies experiencing growing pressure to reduce costs and provide better service can improve their logistics by outsourcing to third-party logistics (3PL) firms, an option that can improve both efficiency and effectiveness, so logistics outsourcing has become a rapidly expanding source of competitive advantage and logistics cost savings. 2.3.1 Productivity Alan Stainer (1997) believe that, in measuring logistics performance, a comprehensive strategy of measurement is necessary for the successful planning, realization and control of the different activities which comprise the business logistics function. He also pointed out that, there should be a family of measures. This is a balanced collection of four to six performance measures, usually including productivity, quality and customer satisfaction, which together furnish an all-inclusive view of results but, individually, also provide a diagnostic value. Within this performance scenario, productivity can be seen as a measurement of resource utilization, including the time element. Alberto G. Canen and Ana Canen, (2002, number: 2.pp: 73-85) points out, the productivity philosophy and its improvement has been a high priority, in the first instance, in manufacturing, then in marketing, and later in physical distribution and materials management. Thus, the time is now ripe to focus on the whole logistics process. The term productivity is often ill-defined but, basically, its measurement is that of a prescribed output to the resources consumed. It can be divided into three main types: Partial measures being a ratio relating output to a single input, such as labour, materials or capital. Total factor or value-added productivity being based on sales less bought-in goods, materials and services. Total productivity measures being a ratio of total output to total input. There is a clear link between productivity and performance improvement, as purported by Lynch and Cross (1995, pp. 63-91). They show performance as a pyramid which is filtered down from the corporate vision, with market and financial measures as the main resultants, supported by customer satisfaction, flexibility and productivity as core business processes. Despite this emphasis on performance, previous research by the author (Stainer and Stainer, 1995), based on a survey of both manufacturing and service industries in the UK, France and Germany, suggests that the implementation of formal productivity programmes is still marginally behind that of the US a decade ago. Further analysis of the survey divulges the use of these three productivity measures for all respondents, as well as for those respondents employing productivity measures in the field of logistics. 2.3.2 Cost The total Logistics cost as a percentage of GDP has widely been used as an indicator of the development level of the Logistics industry in many developed countries. In general, the higher the percentage, the less efficient is the Logistics industry, which means the cost affect the development of logistics industry. The costs associated with logistics activities normally consist of the following components: transportation, warehousing, order processing/customer service, administration, and inventory holding (e.g. Lambert et al., 1998; Saccomano, 1999). Not surprisingly, total logistics costs often represent a large portion of total supply chain costs, especially when the supply chain is extended to the global market. As more organizations are outsourcing their products or services to global suppliers, it becomes increasingly critical to understand and evaluate the various logistics cost components in order to assure the profit margin. 2.3.3 Expansion /outsourcing Elliot Rabinovich, Robert Windle and Martin Dresner, (1999) said that: the outsourcing of logistics functions to partners, known as â€Å"third-party logistics providers†, has increasingly become a powerful alternative to the traditional, vertically-integrated firm in logistics industry. A growth in the number of outsourcing partnerships has contributed to the development of more flexible organizations, based on core competencies and mutually beneficial longer-term relationships. Overall, some 60 per cent of Fortune 500 companies report having at least one contract with a third-party logistics provider. Such buyouts and mergers enable logistics players to build up their infrastructure and service scale, both of which are critical to remaining competitive. By merging their operations and collaborating on technology, complementary services partners can also scale up their logistics capability without having to invest heavily in infrastructure. The result is lower cycle-time, streamlined business processes and lower manpower costs, which in turn boosts companies productivity and profitability. The development of logistics outsourcing broadly defined in this paper as long and short-term contracts or alliances between manufacturing and service firms and third-party logistics providers has been largely based on the needs that companies have to obtain cost savings and to concentrate on their core competencies. They also indicated that, the market and firm characteristics influence the decision to contract multiple combinations of third-party logistics services. These services range from single transportation activities to integrated warehousing, distribution, and information management activities. Also several authors have indicated that across many industries logistics outsourcing has become a rapidly expanding source of competitive advantage and logistics cost savings in logistics industry. For example, Elliot Rabinovich, etl (1999) reported that some firms routinely have achieved up to 30 per cent to 40 per cent reductions in logistics costs and have been able to greatly streamline global logistics processes as a consequence of outsourcing. Other studies, however, have indicated that some logistics outsourcing arrangements are not successful. These