STRATEGY
Merging the Physical and Financial Supply Chains
April 19, 2007
John Hammond, Standard Chartered Bank

China has seen spectacular growth over the last few years as a result of ongoing liberalisation of the market and acceptance within the global economy. The statistical evidence - whether by value or the sheer volume of export or import traffic by road, rail and sea - produces phenomenal figures that are clear indicators of the efforts made in the provision of the physical infrastructure that has supported the advances. There is still much to be done and future development will further reshape the support structures of all sectors including logistics and financial services. Convergence of the physical and financial supply chains is often talked about and this concept can be illustrated in the context of the growth being achieved in China.

It is clear that the logistics industry has been one of the main beneficiaries of the double digit growth - with forwarders, third-party logistics (3PL) providers, airlines, ports and shipping lines struggling to meet demands. Despite the exuberant publicity surrounding such growth rates, there are still huge challenges in the logistics sector, and for that matter any form of business in China.

While offering huge opportunities, the market is undoubtedly one of the most difficult to break into. However, despite the many problems, global transport and logistics companies are investing billions of dollars in infrastructure, acquisitions and operations to anticipate and meet demand.

Regulations, culture, weak infrastructure and an undeveloped industry are just some of the problems. Without an understanding of the country, its markets, its logistics sectors and potential partners, doing business in China is very difficult, while the competition is very strong and well established. Large logistics enterprises with clear advantages - such as Cosco, Sinotrans, CMST, CRC, China Merchants and China Shipping - have been aggressively building information networks, logistics facilities and client relationships in an effort to transform themselves into modern and integrated multi-modal service companies. Industrial and commercial enterprises are also stepping up efforts to consolidate their logistics resources and businesses to form independent or semi-independent entities to centralise their logistics operations.

As domestic logistics enterprises still lack capital and management skills, large-scale mergers and acquisitions are yet to take place in this sector, but there are signs that it is beginning to happen, often through joint ventures.

Partnership with Hong Kong

The Closer Economic Partnership Arrangement (CEPA) between mainland China and Hong Kong has encouraged some Hong Kong-based enterprises to enter the market or expand operations on the mainland.

For trade in services, preferential treatment offered under CEPA takes various forms, including relaxation in equity share restrictions, reduction in the entry thresholds such as registered capital and business turnover, as well as relaxation in restrictions over geographical location and business scope.

There has been a steady rise in the number of Certificate of Hong Kong Service Suppliers in the past two years. Hong Kong's Trade and Industry Department (TID) has issued them to about 900 companies to enable them to apply to the authorities to launch their businesses on the mainland. The most popular sectors are logistics and transport, distribution, advertising, construction and management consultancy.

This can be illustrated by reference to the TID statistics as of 27 January 2006, which show that applications for the logistics sector (from a total of 967 applications and 924 approvals) accounted for almost 75% of those approved.

Challenges Facing the Chinese Logistics Industry

A 2004 report by UK market research consultancy Transport Intelligence cites the following challenges for the logistics industry in China:

Poor infrastructure
One of the key challenges is the state of the country's transport infrastructure. At present, despite some large-scale projects, companies complain of insufficient integration of transport networks, IT, warehousing and distribution facilities. Outside of the main economic centres, the logistics sector tends to be of low quality, highly inefficient and with little technological competence.

Regulation
Although it is slowly opening up to outside competition, the Chinese transportation and logistics market is one of the most highly regulated in the world. Regulation exists at a number of different tiers, imposed by national, regional and local authorities. Regulations often differ from city to city, hindering the creation of national networks.

Bureaucracy and culture
Getting the go-ahead for any logistics project in China still relies heavily on the strength of contacts that companies have within Chinese bureaucracy.

Poor training
Training in the 3PL, manufacturing and retailing sectors is very weak at a practical level - with IT, driving and warehouse - as well as at a strategic level. Many do not realise the benefits that best practice in logistics can bring to their companies and are therefore not interested in the opportunities of outsourcing or of supply chain management.

Information and communications technology
Outside of the main logistics centres, information and communications technology and infrastructure is unreliable. There is a lack of IT standards and poor systems integration and equipment. At a very basic level, the consistent supply of energy is also problematic, leading to interruptions to communications because of power cuts.

Undeveloped domestic industry
The Chinese logistics sector is fragmented and dominated by low-quality transport and warehousing connected with separate products, providing little base on which to build a modern industry. This also makes it difficult to meet the growing supply chain demands for industrial and commercial enterprises.

High transport costs
Some estimates put the cost of transporting goods in China at up to 50% more than in developed regions such as Japan, Europe and North America. These costs are increased by high tolls on roads. Logistics costs (including warehousing, distribution, inventory holding and order processing) are estimated to be two to three times the norm and in excess of 20%.

Poor warehousing and storage
Poor facilities and management are to blame for high levels of loss, damage and deterioration of stock, especially for perishables. For instance, it is estimated that 30% of China's fruit and vegetable harvest is damaged every year by the inability to store and move it appropriately, costing US$1bn for this sector alone. Part of the problem is insufficient specialist equipment, such as refrigerated storage and containers, but it is also partly through lack of training.

Regional imbalance
China's economy is characterised by wide variations in levels of economic activity and development. This is problematic for distribution as there is a major imbalance in the flow of goods from the developed east of the country to the more undeveloped west. This has resulted in difficulties in finding backloads, leading to higher costs for Chinese haulage companies that are then passed on to their clients. Internationally these imbalances also exist between China and the rest of the world, leading to difficulties in repositioning empty containers.

Domestic trade barriers
Although China's accession to the World Trade Organisation has lowered barriers such as tariffs and quotas for international shipments, there are still problems with moving goods around China itself. Goods can even be subject to unofficial border tolls when moving between provinces. This is particularly evident when shipping from an inland manufacturing location to a port city or vice versa.

This last factor in the Transport Intelligence report can be illustrated in Hong Kong, where the cost of moving goods from China to a Hong Kong container terminal is affected by the need to cross a boundary with both Chinese and Hong Kong Customs procedures to be negotiated. There is also the extra distance involved and a financial penalty from the imposition of a 'terminal handling charge', which is a source of constant debate when the competitive position of Hong Kong is compared with other Pearl River Delta (PRD) ports such as Shenzhen or Yentian.

This situation may change if the proposed Zhuhai bridge project proceeds. More than a road link between Hong Kong, Zhuhai and Macau, the bridge is intended to open up the western PRD to industrial expansion and to entice cargo shipments via Hong Kong. There are a number of issues to be resolved before this major project goes ahead. Apart from the engineering feat, the question of further development in the PRD has a strong political and environmental component as the area already suffers from significant industrial air pollution.

Convergence with the Financial Services Sector

In trading with China, most major business is done with the protection of trade insurance and letters of credit. It is generally accepted that there will be a decline in the use of the documentary credit as the terms of trade change to reflect a greater sophistication in the process of trade and supply chain management when dealing with China-based suppliers.

The 'open account' agreements that rely more on the stable relationship between buyer and seller and a less rigorous compliance regime are leading to the development of new asset management or supply chain finance products. These products will in themselves rely on the quality of the relationship between the bank and their customers and the willingness of the parties to collaborate in ensuring end-to-end visibility.

Buyers are now looking to their banks to co-operate in financing both buyer and supplier and to collaborate in the supply chain process by contributing to the provision of information relating to the status of the documentation and finance process, linked to the physical movement, on a global basis.

From a banking perspective, this expectation requires the bank to work with customers and their suppliers and their respective service providers to create a network of collaboration that will satisfy the need for an improved service. This often entails the use of technology to exchange data in a secure environment. In recent years, the Internet has offered the means to develop new capabilities and modern business practices that are secure and cost-effective.

The financial services industry has adopted these technologies and is now routinely offering online banking that includes data capture of, for example, purchase orders and invoices and the automated processing of traditional letter-of-credit applications. The same technology is used to share data, which assists visibility of a particular trade and offers status information that lessens the risks associated with 'open account' financing.

Given a collaborative agreement with the customer's logistics provider, it is now possible to capture the status information related to the movement of goods and apply this to the bank's documentary processes and risk management procedures.

Supply Chain Management

The just-in-time world of supply chain management has been overtaken by more sophisticated forward logistics and financial planning that has driven the movement towards open-account trading. The industry is also seeing more 'free delivered' trade terms suggesting that importers are willing to place more reliance on the supplier and the logistics provider, be that 3PL or ocean carrier, to ensure delivery on time. In response to these changing trade patterns, the demand from customers for greater collaboration and the commercial and technical ability to accomplish this is becoming a vital factor in both the logistics and financial sectors.

Developments are taking place in the logistics sector with the creation of web-based services and the establishment of portals such as INTTRA, GT-Nexus and CargoSmart in the marine industry. The ports, air transport and global courier services are also moving in a similar direction with the potential for cross-industry collaboration. A convergence of the physical and financial supply chains is a natural progression made possible by advances in technology in response to the business needs of a developing world economy.

Copyright © ChinaForum 2007