Supply Chain Management in China

Analysis

Much of that growth will be consolidation-driven. Of the more than 18,000 registered companies claiming to offer logistics services in China, not one offers nationwide distribution services. In fact, no single logistics provider commands more than 2 percent of the market. Because of this industry fragmentation, the merging of logistics providers and the development of third-party logistics services are inevitable—especially given shippers' demands for greater efficiencies, scale, breadth of service offerings and network coverage.

Competition already is intensifying in the third-party logistics market, forcing a consolidation of this area as a whole. While foreign companies with strong international networks and better management are gaining market share, many domestic companies rely on underdeveloped homegrown operations. Local and regional distribution systems are replacing state-owned and centrally-managed trading and distribution systems.

According to a 2002 report, the outsourcing of logistics and transportation will continue to expand by roughly 25 percent annually through 2005 because of stronger global interest and demand for third-party services.¹ Multinational companies (MNCs) relying on China as a global sourcing base are inclined to use—and are experienced in using—third-party services, especially those of third-party providers. More than 90 percent of MNCs in China currently contract at least a portion of their logistics business to third parties. These foreign companies have shown Chinese companies that they do not need to own all of the assets involved in service provision in order to offer a full line of services.

The Rise of Alliances and Joint Ventures
Another major trend in distribution and logistics has been the rise of alliances and joint ventures (JVs), as the top companies in China combine forces to build competitive national distribution chains targeting specific industries. In June 2002, Legend Group, Ltd., and APL Logistics (the logistics branch of the NOL Group) announced the formation of a third-party logistics service joint venture to offer specialized logistics services for the information technology industry. Similar joint ventures have been formed by the TNT Group and the Shanghai Auto Industry Group, among others.

Chinese and foreign companies across many industries in China have achieved success through the support of strong, modern distribution networks. Guangzhou Honda Automobile Co., initiated exclusive four-in-one franchises (sales, repair and maintenance, supply of parts and components, and information service) in China that have enabled it to strengthen its brand name and position by better controlling service quality, product price, and market information. The formation of the SAIC-Volkswagen Sales Co., Ltd., in 2000 is another example of a foreign company seeking to participate directly in the distribution business by building a dedicated distribution and after-sales support network.

Potential Delays in WTO Rule Implementation
More than 80 percent of Fortune 500 companies have already invested in China. However, small and medium-size foreign companies are just now entering the country. But regardless of the depth of their experience in China, all companies face ongoing risks in the regulatory, political, and market arenas. One such risk involves World Trade Organization (WTO) commitment delays. China may delay WTO implementation and regulate competition to help local companies compete in the market. As other WTO members have done, China also may work around WTO rules to maintain barriers against imports—for example, by erecting WTO-compatible non-tariff barriers, such as licensing, health, technical and packaging standards.

China recently released a draft regulation that would require "one license, one product" dealership licenses in the auto sector. These would prevent newcomers from using existing distribution channels and give local manufacturers more time to prepare for direct competition. Another important risk is regulatory fragmentation. China's distribution and logistics industry has been micro-regulated for years, with different logistics service components governed as distinct subsectors by various government departments. For example, the Ministry of Communications governs land and waterway transportation; the Ministry of Commerce administers trading rights and international freight forwarding licenses; and the General Administration of Customs of the People's Republic of China (PRC) controls brokerage services. Despite central government efforts to promote coordination, this shared jurisdiction system is unlikely to disappear quickly, so companies still must acquire separate licenses through various governing bodies to undertake different activities.

Lack of enforcement capability and local protectionism also can cause problems. China's governing structure encompasses multiple layers of central and local governments. Despite central government efforts to liberalize the market, local-level interpretation and enforcement of laws and regulations can often be arbitrary and inequitably disposed toward local interests.

Large Fluctuations in Capacity and Demand
Business risks associated with fluctuating capacity and demand are yet another concern. China has one of the most dynamic markets in the world, making errors in market demand forecasts more frequent and severe than those in other areas. In addition, almost all major cities and regions in China have invested in some form of distribution or warehousing center or logistics park. But, according to research conducted by the China Storage Association in 2002, 60 percent of the country's logistics centers are empty. Lastly, social and political risks must be considered.

China Federation of Logistics and Purchasing, and Mercer Management Consulting.

 
Recommendations

Foreign companies planning to enter China through a partnership or joint venture must be extremely careful about their potential partners' visible and invisible liabilities. For example, protecting local employment is a high priority for PRC governments, so appropriate benefits for excess workers can be a huge issue in contract negotiations. Deft handling of corruption (particularly common at local levels) also is essential.

As some successful companies are proving, effectiveness in distribution and logistics helps to achieve market share and profitability growth in China. However, to realize the true potential of the burgeoning China market, a great deal of homework and due diligence are still essential.

First and foremost, companies must work to understand this radically different market. Contrary to what some experts think, cost and time concerns will limit the swiftness with which shippers develop their own sales and distribution approaches once China fulfills its WTO commitments in distribution services. Instead, smart players will work to enhance the capabilities of the PRC distributors with which they already have relationships.

They also will pay attention to regional and local particulars, and acknowledge the intense emphasis that Chinese companies place on relationships. Every city or investment zone has different policies designed to attract certain types of foreign investment. For example, some zones provide local tax incentives, land leasing, and lower utility fees. Organizations such as the US-China Business Council and the American Chamber of Commerce can help find appropriate locations. A well-connected and trustworthy local partner also is important.

The need to focus on value is a second key strategy. Companies should bypass inefficient parties and middlemen—thereby removing unnecessary layers of bureaucracy and streamlining distribution chains. This is already happening in many industries, such as personal computers and consumer electronics. Nokia, for example, has sidestepped the widely used industry distribution model that follows a "manufacturer, general agent, regional distributor, second tier distributor, retailer, consumer" pattern. Instead, it supplies large regional distributors and retail outlets directly, thus cutting distribution costs and raising market responsiveness.

A third imperative is to streamline distribution and logistics. Companies and their distributors must integrate, centralize and streamline distribution and logistics functions, assets, infrastructure, staff and operations. The long-term goal is for the supply chain to become a separate—yet shared—organization across different business units. Few companies can build or provide a full range of distribution services alone, which is why it is vital to build partnerships and alliances with local distribution service providers.

By focusing on improving flows, companies' distribution and logistics functions in China can be based more on the transmission of reliable and timely information, and less on direct control of the physical movement of consignments. To help make this happen, they also must emphasize the creative use of technology. The distribution and logistics sector in China is typically slow to adopt new technologies, partly because of the complexity and cost of setting up an integrated IT platform. Growth of the sector will require particularly great sophistication in supply chain planning, product visibility and end-to-end supply chain integration.

Finally, there will be an exceptional need to build and retain talent for long-term success. According to a 2002 survey by The Logistics Institute-Asia Pacific and The Logistics Institute of the Georgia Institute of Technology, a premier obstacle to operating in China is lack of talent. Value-added services in distribution and logistics require more expertise than most PRC providers currently possess. In fact, some observers believe that 85 to 90 percent of failed distribution initiatives were caused by workforce error. For the foreseeable future, training will be an integral part of any company's relationship with a PRC distribution service provider.

Like few other countries, China is a nation of dramatic contrasts: old and new, national and local, modern and antiquated. The same holds true in its business environment: The challenges are daunting and the risks are great, but the opportunities are immense. In China, nothing is impossible, but everything is difficult.