Supply Chain Management in China: Assessments and Directions
Since joining the World Trade Organization (WTO) in 2001, China is becoming a
more viable market. According to The New York Times, the Chinese now buy more
cellular phones than any other country. They also purchase about 100,000 Buicks
annually and patronize nearly 1,000 McDonald's, KFC, Pizza Hut, and Starbucks
outlets.1 It's therefore no surprise that China's economy
is growing by nearly 8 percent per year, despite a global slowdown.
However, companies doing business in China still face the following supply chain challenges: inadequate services, fragmented logistics systems, a legacy of local protectionism, few third-party capabilities, and numerous anachronistic laws. China's geography also presents an additional challenge, since its Western and interior regions (where two-thirds of the population live) are largely inaccessible. This paper examines the state of China's transportation and distribution infrastructure, summarizes the principal regulatory challenges faced by companies doing business in the country, and concludes with a discussion of the future of supply chain management.
Infrastructure Challenges
Although it is one of the world's most industrialized nations, China lags with respect to infrastructure. Consequently, companies entering the Chinese market often cannot apply standard logistical approaches. Rail, for example, is China's cheapest distribution method — the result of longstanding priorities given to moving military and strategic commodities. However, capacity shortages are routine, resulting in unmet demand for cargo space. The Ministry of Railways (MOR) controls most of the country's rail service, although China Ocean Shipping Company (COSCO) and Sinotrans (China National Foreign Trade Transportation Corporation) also offer limited service. Traditionally, these entities have focused on passenger services, but an awareness of the need for better rail-freight capabilities is emerging. The MOR has spearheaded several projects to upgrade China's rail infrastructure and increase capacity and travel speed.
Road transport is the preferred option for moving packaged finished goods, which is why China is investing billions of dollars on upgrades. The China Business Review reported that China spent $26.6 billion on 50,000 kilometers of new highways in 2000, including 4,561 kilometers of new expressways.2 However, these initiatives are strained by strong demand and the extensive fragmentation of China's road transport industry, where 5.4 million trucks are registered to more than 2 million trucking providers.
Airfreight is expected to grow considerably over the long term but is currently plagued by high prices, fragmented routes, limited information exchange among airlines and forwarders, and inadequate cargo capacity. Moreover, freight forwarders rarely provide the kind of basic, value-added services enjoyed in the United States and Europe. The upside is that China is allocating billions to airport construction and expansion.
Ocean and inland water transport is China's most developed distribution sector, with more than 1,200 ocean and river ports offering berths for 33,000 ships — including more than 780 deep-water berths capable of handling 10,000-ton vessels. China's shipping companies also rank among the world's largest. However, inland water transport for domestic distribution is underutilized because ports cannot process and manage cargo efficiently, bureaucratic delays and pilferage are common, and many ports often cannot accommodate larger cargo vessels. Responding to these concerns, China has invested $1.7 billion in inland water transportation, with the goal of developing an international-standard container network with intermodal capabilities.
In general, China's distribution infrastructure is hampered by inefficient warehouse designs, low ceilings, and poor lighting. Goods usually are handled manually, without racking or warehouse automation. In response, the government — which controls 90 percent of China's warehousing capacity — plans to build 30 distribution and logistics centers. Two such initiatives are in Shanghai, where $15 billion is being invested to build a world-class logistics business. Similar facilities also are being built in Beijing.
Regulatory Challenges
One of the largest regulatory concerns is that most supply chain services in China are not logically linked to government departments. Instead, logistics oversight is shared by entities such as the State Domestic Trade Bureau, State and Economic Trade Commission, and State Development Planning Commission. One process that suffers from this sharing of responsibility is customs clearance, which is often dogged by excessive paperwork, inefficient procedures, and short business hours. On the positive side, customs is a high-profile issue, and significant improvements — including increased computerization — are therefore taking hold.
Complicated and excessive regulatory controls also are common. For example, foreign trade corporations must sell goods through distributors rather than to stores, and they are forbidden to own distribution channels and logistics infrastructure. They must therefore rely on small local companies to distribute product through multitiered wholesaler channels, since China has few — if any — national distributors (see Figure 1).
Figure 1: An example of a typical supply chain network for a consumer products company operating in China.
In response to regulations, companies doing business in China often have little choice but to develop redundant structures, assets, operations, and contractual relationships. This is because a foreign-owned plant can sell goods manufactured in China, but it cannot sell or distribute goods imported into the country — including those made by an out-of-country sister plant. Nor can parent companies holding foreign-owned companies in China sell products from other company plants. These barriers prevent foreign companies from consolidating shipments going to the same customer, as well as issuing consolidated invoices.
Lastly, regulatory blocks have created a shortage of third-party logistics providers. At present, no logistics company has more than a 2 percent share of the China market. And only four wholly owned foreign enterprises offer logistics services outside of special zones within China.
Drivers Fueling Reform
Despite China's infrastructure and regulatory barriers, there is strong cause for optimism. One reason is simply the power of the market: China's population (currently 1.2 billion) is expected to grow by 15 million people per year, and its gross national product (currently $816 billion) will increase by 8 to 9 percent per year. Concurrent with this growth, Chinese industries are consolidating, which is inspiring retailers to push into new markets and is intensifying the call to modernize China's supply chain infrastructure.
The government is listening. In fact, modernization of logistics and transportation is one of the top three priorities cited in China's Tenth Five-Year Plan (2001-2005). As noted earlier, China's state and provincial governments also are making huge investments to upgrade infrastructure and build logistics centers and hubs to promote consolidation and collaboration.
Additionally, as a result of China's admission to the WTO, the country will progressively remove restrictions that prevent foreign companies from participating in transportation and distribution (see Figure 2). WTO status also will stimulate economic growth by opening China's economy to competition and encouraging collaboration between local and foreign companies. Within a year, foreign companies will be permitted to distribute imported products and hold majority shares in logistics joint ventures. Within three to four years, all restrictions on primary and ancillary logistics services will be phased out, making it possible for foreign companies to set up 100 percent foreign-owned subsidiaries covering a variety of supply chain management functions.
Figure 2: Post-WTO Accession Regulations
Looking Ahead
Sustained growth, favorable government policies, and membership of the WTO will drive significant changes in China's supply chain landscape over the next five to 10 years:
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1. An expanding market and increasing demand will position supply chain management
as a competitive differentiator. Since the government and businesses now
recognize the immensity and impact of China's supply chain performance gap —
and for the first time are in a position to do something about it — status
quo performance will become less acceptable.
2. China's presence in the WTO will produce major economic changes, but transition delays and frustrations will be unavoidable. The depth and duration of these delays will depend on how liberally the government treats the logistics sector and how committed it is to exposing domestic players to open competition. Most likely, China will manage these efforts carefully, and in a way that maximizes opportunities to pass management and operational expertise on to local companies. The government's objective is to give local logistics providers enough time to handle competition effectively. The government 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.
3. Rapid changes in China's business and consumer environment will dilute the emphasis on guanxi (assigning paramount importance to relationships). Strong networks and relationships are important throughout the world, but China's emphasis on guanxi often has come at the expense of commercial realities. This will change.
4. Competition and consolidation will intensify. This will be particularly true in consumer goods, where significant consolidation already has 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 implies that significant duplication of logistics assets exists.
5. Ports will become more efficient. Greater trade flows, intensified competition, increasing demands from shippers for better service, and more foreign investment will lead to changes in the port sector. Since the inefficiency of China's ports is one of the largest 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 up to a 49 percent stake in shipping joint ventures and participate in port development projects.
6. Distribution channels will not proliferate. Given the time and expense, it is unlikely that shippers will rush to develop their own distribution channels and wholesale networks. Most will continue to rely on local partners to reach second-tier cities and remote regions. They also will look for ways to de-layer existing wholesaler structures and build long-term relationships with major distributors that already operate distribution networks.
7. Integration, centralization, and rationalization of supply chain functions, assets, infrastructure, and operations will be widespread. This will be fueled by removal of regulatory restrictions, rising customer demands for one-stop service, and the recognition that significant cost savings are achievable. Given the potential benefits, a rise in the number of supply chain shared service organizations is likely.
8. Third-party logistics providers will mature and consolidate. The opportunity for third-party logistics providers to incorporate wholly-owned foreign enterprises within three years of WTO accession is significant. It should attract foreign firms to an industry projected to grow by more than 30 percent per year for the next five years — and one that is very willing to invest in the infrastructure projects needed to create a modern, national, logistics network. Many players already are joining the fray, including traditional Chinese logistics companies, new logistics companies, the internal logistics departments of Chinese companies, and foreign service providers. This will force a consolidation of the entire industry, as it did in the United States and Europe.
9. Ministries, state-owned enterprises (SOEs), and local logistics firms will restructure. WTO membership will provide Chinese consumers, customers, and shippers with more choice, which means more competition. Thus, China's accession to the WTO will have a more profound effect on local Chinese companies than it will on China-based multinationals. There also will be strong impetus for entities such as the MOR, SOEs, and local firms to develop more efficient capabilities. The current thinking is that China has three or four years to restructure its companies and industries before foreign providers become a significant force.
10. Outsourcing will grow in scope and acceptance. According to Morgan Stanley, third-party logistics service providers have captured only 2 percent of China's overall logistics business, compared with 8 percent in the United States and 10 percent in Europe.3 This will change significantly.
No one believes that China's road to supply chain excellence will be free of bumps or barriers. However, it also is clear that the right conditions — strong market demand, an enlightened perspective, and serious commitments from within and without — are in place. The challenges are daunting and the risks are great, but the opportunities are immense. Supply chains in China clearly are on the edge — the edge of spectacular change.
