China: The Dragon Awakens

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Chinese cities are teeming with manufacturing initiatives, prompting numerous expansions of the country's transportation and logistics infrastructure.

With a population of 1.3 billion, representing 25 percent of the world's population, China is one of the fastest-evolving countries from a logistics, manufacturing, and production perspective, says Rick Moradian, vice president of international logistics for APL Logistics, a third-party logistics provider based in Oakland, Calif.

Although the Chinese government is investing heavily in roads, rails, air and ocean ports, as well as state-of-the-art material handling equipment to improve and expand its infrastructure, continuous manufacturing growth keeps outpacing these efforts. That causes some to refer to aspects of China's infrastructure as 'spotty.'

"The existing infrastructure cannot handle the volume of growth effectively, and these issues will haunt China for some time," Moradian says, adding that transportation costs for cargo can be considerably higher in China than in countries with more developed infrastructures.

U.S. and other foreign companies surging to China's shores to set up shop and take advantage of attractive incentives—including low-cost labor—find China is a country of jarring contrasts, both from a business and socio-economical point of view.

"There's a split between the old and the new in China, with a lot of poverty in the west and a growing middle class in the east, where all the good jobs are," says Richard Lancioni, Ph.D., professor of logistics at Temple University, Philadelphia. "The country is highly regionalized and its inhabitants are loyal to their home provinces."

In some ways, China seems like a collection of different countries in terms of its various cultures, language dialects, and habits," says William Dodson, managing director of Chicago-based Silk Road Communications, which offers business development services to U.S. companies considering a China presence.

China's transportation and logistics infrastructure is also marked by dramatic contrasts such as carrier trucks sharing modern highways and dirt roads with donkey carts.

Most U.S. companies perceive China's infrastructure as something they need to work around, notes Chris Runckel, president, Runckel Associates, Portland, Ore. "It's not uncommon to find the roads are jammed and it takes a long time to get products to the port; but companies build that into their business plan," he says.

Despite some of the challenges, U.S. companies are reaping the benefits of operating in China. China's imports grew 40 percent and its exports grew 35 percent in 2003, notes Rosalyn Wilson, author of the 15th annual State of Logistics report.

"China is home to nine of the world's top 50 ports, which account for about 27 percent of the world's containerized cargo," Wilson says.

Just a few years ago, Moradian referred to logistics services in China as "primitive." But that has changed. "Tremendous advancements have been made to facilitate seamless product flow throughout the country and to U.S. destinations," he says.

Today, China's logistics industry generates between 18 and 20 percent of the country's Gross Domestic Product—double the U.S. level, notes Chelsea C. White, III, ISyE Chair of Transportation and Logistics, School of Industrial and Systems Engineering at Georgia Institute of Technology.

"One reason is that China's economy is based on manufacturing, while the U.S. economy is based on service," White says.

Even so, the country still lacks a fortified and cohesive logistics infrastructure, notes Moradian.

White adds the relatively inefficient Chinese logistics industry will likely undergo heavy consolidation. "This will be a function of the regulations China is beginning to put together to influence the development of a modern and efficient logistics industry," White says.

Individual provinces interpret national logistics laws differently from one another, so national cohesiveness remains a goal.

Geography and Infrastructure: Blending the Old with the New

To better understand the challenges and benefits of operating in China, it helps to get a handle on the company's geography and transportation infrastructure. For thousands of years, river transportation has been a major mode in China.

And it's more than tradition that keeps commerce flowing efficiently on rivers even into the 21st century. Take, for example, Ford Motor Company's recent pledge to invest significantly in the Chongqing area along the Yangtze River.

"Why would a company like Ford choose to enter a joint venture with Changan Automotive, one of China's largest automotive manufacturers, located in what appears to be the middle of nowhere?" Dodson asks. "The draw for Ford was its customer needed to be supplied and the nearby waterway is used to ship parts via containers on barge."

Ford will also invest another $1 billion in the Nanjing area, further east and north of Chongqing on the Yangtze.

The vitality of the river is its east-west direction because there are no inter-provincial or national east-west highway systems in China—just a major north-south highway from Shenyang south to Guangzhou near Hong Kong.

"This kind of development begins and ends with the customer and you have to follow your customers around the globe," Dodson says.

Jordan Industries, a manufacturer of bicycle reflectors and small motors based in Deerfield, Ill., knows this all too well. "Because most of the world's bicycle manufacturing has moved to China we were in the position of losing all our business unless we moved there too. We needed a local presence to supply manufacturers with our bicycle reflectors," says Andrew Rice, vice president.

Another benefit of river transportation is Free Trade Zones (FTZs). "FTZs are great if you export from China. From an infrastructure point of view, they are set up along the seacoast or riverway cities such as Ningbo, across the Yangtze River delta from Shanghai, and Dalian in the north," Dodson says.

In addition, several state-approved Economic Development Zones such as those in Suzhou, Kunshan, and Ningbo also incorporate Export Processing Zones (EPZs), which can expedite customs processing.

"The Economic Development Zones are where U.S. companies want to set up because the infrastructures are most developed," Dodson notes.

China's ports are modern and well-developed, with Shanghai, Hong Kong, and Shenzhen the top three busiest ports in the world, boasting highly automated material handling equipment, he adds.

East Vs. West

China's eastern coastal cities are as modern as any of the world's top commercial hubs. About 15 percent of China's land mass on the east coast supports about 80 percent of the country's wealth. Yet, about 80 percent of China's population inhabits the west, which is virtually undeveloped. Five key provinces on the eastern coast of China produce between 70 and 80 percent of all exports.

"The proximity to ocean and river ports allows manufactured goods to be exported without any hindrances or domestic constraints," says Moradian.

Cities in this region include, from south to north, Macau, Hong Kong, Guangzhou, Shanghai, Nanjing, Tianjin, and Beijing.

The Chinese government, it seems, has a Go West policy, encouraging manufacturing companies to locate inland to create more jobs. But that policy is still far from reality. Current road and rail networks and inland ports—whether airports or river ports—have not expanded enough to handle this type of migration, Moradian says.

Foreign investors, as well as the Chinese government and domestic investors, are helping to bolster the interior's infrastructure. Infrastructure in the Shanghai area is growing overheated and stressed, says Silk Road's Dodson.

"Companies are flocking to Shanghai, and the provinces of Jiangsu, where Suzhou and Nanjing are located, as well as to Zhejiang, where Hangzhou and Ningbo are located," he says. "About 45 to 50 percent of foreign investments flow into China within these three areas."

With such intense squeezing of the infrastructure's resources, companies are already beginning a westward migration, first toward Suzhou, Dodson says. "Five or 10 years ago, Shanghai was the place to be, but it's becoming congested and costs there are rising phenomenally," he says.

Suzhou's proximity to the Yangtze River is a benefit that the manufacturing community recognizes. "The inevitable westward expansion of foreign investment may see Nanjing, or even Wuhu in rural Anhui province, become the next manufacturing hot spots in China in the near future," Dodson says.

Further west into the interior, cities such as Xian, Chengdu, and Lanzhou also are being developed, with Xian experiencing some major development. Chengdu is already home to a Motorola R&D facility and Intel is building a $200 million plant there.

"The region overall is seeing considerable investment in new roads and other infrastructure components to encourage businesses to locate there," Runckel says.

Economic Backbone

China's economic structure consists of three main regions: Hong Kong in the southeast, Shanghai in the central east, and Beijing and Tianjin in the northeast.

"These economic regions are exporting from China and they have a mission to establish a domestic market in the future," says Victor Mok, managing director for Exel in East Asia.

Shanghai is the most modern city in the country, with a thriving population of 17 million. Although Shanghai is a major port, it cannot accept deep vessels, so factories located in the region have to send their shipments to Ningbo, about 60 miles north. But the port is projected to be the world's largest in the near future, as the government constructs deep seaports there.

Guangzhou, south of Shanghai and north of Hong Kong, developed several years earlier, so the high costs of operation there cause companies to choose other locations, Runckel says.

While the roads leave something to be desired in some areas, White notes the investment China is making in developing a highway network is substantially larger than what the United States spent to build the Interstate Highway System in the 1950s.

The Taiwan Issue

About 500 miles from Hong Kong off the coast of China, Taiwan enjoys a vibrant economy as a separate country.

"The Chinese government refers to Taiwan as a 'rogue province,'" notes Lancioni. "It's still a sticking point. U.S.-China relationships can be a lot closer if the Taiwan issue is resolved."

The Taiwanese culture performs a critical role in linking the western world with the Chinese world. "We all understand there are issues, but economically Taiwan is very important to the greater China area and to economic development," Mok says, adding Taiwan's GDP exceeds $300 billion (US). "U.S. companies seeking to expand into China might want to look at greater China as one piece because it's a lot bigger than just the People's Republic of China."

Chinese citizens need permission to travel to Taiwan, and the port of entry is in Shanghai exclusively. "If a U.S. company has operations in Taiwan and China, travel back and forth could present some challenges," notes Lancioni.

Operating in China: Incentives and Bottlenecks

The recent U.S.-China maritime agreement means U.S. companies can operate within China as easily as Chinese entities operate within the Americas. The agreement also means more capacity in China to move products to the United States. Business incentives are getting more competitive as cities vie to win over U.S. companies.

"Cities are offering land at a discount, subsidizing the cost of building your facility, and giving relief on import duties," says Rice at Jordan Industries. In return, companies are expected to meet certain sales goals and to employ locals—similar to U.S. cities and states competing by offering attractive incentives packages.

Technical universities also are popping up within these areas, so there is a supply of well-trained people to make up the workforce.

Joint Ventures: Caution!

Siva Yam, president of the Chicago-based U.S.-China Chamber of Commerce, cautions against entering China through a joint venture (JV).

"In the old days, that was the only way to go because joint ventures offered good incentives to both parties," he says. "The Chinese were looking for foreign capital, new technologies, and access to foreign markets in exchange for facilities, a workforce, and 'guanxi' to help get licenses, permits, and other required documentation."

Even so, joint ventures still thrive in the country. For instance, Shanghai Automotive is a five-year-old JV between SAIC, China's largest automotive manufacturer, and GM-China. The partnership was established to provide automobiles to the Chinese market—primarily Buicks, regarded locally as popular and prestigious. GM also sources components in China and ships to the States for assembly in its plants there.

Sourcing Costs and Benefits

A growing trend among the Big Three automakers is to source components from China, then ship back to manufacturers' U.S. warehouses, where they will carry up to 40 days' worth of inventory due to uncertainties in the longer supply chain.

"Generally speaking, if the total cost of sourcing internationally is 25 percent less than the domestic cost, it becomes economically viable to consider," says Robert Handfield, head of the Supply Chain Consortium at North Carolina State University, Raleigh.

With the benefit of sourcing in China come some costs, however. Components and products heading to U.S. shores can be held up for some time while waiting to call the ports in California. The tremendous bottlenecks at West Coast ports are felt all the way back to China, affecting a wide range of manufacturers and retailers all along the supply chain.

"At any given time up to 10 ships could be in the Los Angeles harbor waiting to deliver materials, and they could be left waiting for days or up to two weeks," Handfield says.

One mission of the Supply Chain Consortium is to identify supply chain risks and to provide solutions so companies can more effectively manage the long and involved international supply chain.

Avoiding Other Bottlenecks

Documentation is another issue that can bottleneck the supply chain. "The various regulations to be aware of, and what and where to file, can be mind-boggling," says Wilson.

Bureaucratic regulatory constraints—from permit requirements to rules and regulations that vary from province to province—can hinder the free flow of goods, Moradian adds.

Just about every logistics function—freight forwarding, warehousing, distribution, trucking, air freight, importing, and reverse logistics—requires a permit.

"In Asia, a single missing document can hold up your goods for months," Moradian says. "The Council of Logistics Management defines three logistics flows: product flow, information flow, and funds flow. Operating in Asia, however, add a fourth: document flow. If you don't do the fourth, none of the other three matter in the Asian environment."

3PLs to the Rescue?

Some U.S. companies find working with a third-party logistics provider can make operating in China a lot easier.

"Part of APL Logistics' role in China is to internationalize the processes we provide, so those services don't change whether you are operating in China, Europe, or the Americas," says Moradian. "This means handing off to local trucking companies, ports activities, customs clearance, or resolving documentation or visa issues."

APL Logistics plays the role of facilitator, able to handle whatever variables might hinder the movement of goods.

"The world is a lot different today and we have to consider unstable political structures, which could include local issues such as port strikes or blackouts," he says.

Blackouts in particular are an issue because China's electrical infrastructure is overstressed, with shortages causing manufacturers to shut down operations for two or three days during the week. Although companies compensate by operating during evenings or weekends, "it affects the rhythm of manufacturing processes, and you have to build this into your process planning," Rice says.

Third-party logistics provider Exel also helps companies get established in China. Exel provides what it calls "inbound to manufacturing" services. Once Exel has helped U.S. companies move their capital equipment to China, it helps them plan distribution.

"We help them with domestic sourcing to support their local factories—as well as domestic sourcing to support their overseas factories," says Chung.

Exel and other 3PLs help ensure companies have the licenses and other documentation so products can flow unhindered to and from airports and ocean ports and within the country, especially from province to province.

Exel's consolidation services provide purchase order management and origin pre-distribution programs for manufacturers and retailers—including factory pickup, origin trucking services, and freight consolidation from multiple vendors within a geographical region.

"We also offer value-added services such as pick-and-pack, barcode scanning, bundling, labeling, and a DC bypass program," says Michael McIntyre, vice president for Exel's Asia Pacific consolidation services business.

The DC bypass program involves consolidating freight at origin from multiple vendors or factories within a region. Instead of being shipped to the manufacturer's U.S. distribution center, the products are sent directly to the end customer's U.S. distribution center.

In addition, 3PLs can ease customers through the import and export process using technology for increased visibility of distribution and logistics operations says Exel's McIntyre.

On the U.S. inbound side of the picture, companies such as Sinotrans Shipping Agency (NA) can help U.S. companies ensure seamless delivery of their cargo.

"Our company works with cargo receivers on the origin and destination ends of the supply chain," says Patrick Dinon, president of the Long Beach, Calif., agency which is part of Sinotrans Group, a logistics company in China employing more than 50,000 people.

About 50 percent of inbound cargo remains in southern California and is either shipped to other West Coast destinations, or stored in the extensive warehousing and DC network there. On the outbound side, the majority of cargo heading to China includes waste paper and raw material such as cotton.

"For example, American Chung Nam, one of the largest exporters in the United States, operates major mills in Mainland China, manufacturing boxes that often are exported back to the United States," Dinon explains.

Future Vistas

U.S. companies can profit by operating in China, despite some of the inherent pitfalls. One such pitfall was experienced by Suzhou-based Univertical, which manufactures anodes and chemicals used in the plating and PCB industries.

"A lack of a thorough understanding of customs law cost us about $30,000 in fines, freight, and equipment," says Kevin Williams, Univertical's general manager.

Another major challenge facing China and many other emerging economies is to ensure that the legal system represents an enabling infrastructure for international business.

"In China there is a saying that once a contract is signed, serious negotiations begin," White says.

The Growing Middle Class

Although many Chinese still live in conditions of poverty, the number of workers with disposable incomes in the East is growing into a new middle class. This phenomenon is encouraging to U.S. manufacturers in China, who also have the Chinese market in which to sell products.

"The Chinese middle class is the fastest-growing sector in the world," says Wilson. "If trends continue, by 2007 the Chinese middle class market will be larger than the entire U.S. market," says Wilson.

The Chinese economy is built on a value-oriented methodology. "The country is producing things to sell, so it's bulk product in and finished goods out," Lancioni says. "Countries with this kind of characteristic trade flow tend to have more rapid growth and fewer fluctuations compared to a country bringing in exports and shipping out bulk commodities. That scenario is what helped Japan grow so rapidly."

The recent World Trade Organization agreement has resulted in an open-door trade policy between China and the rest of the world. This means many new opportunities for U.S. companies to pursue.

"China welcomes foreign companies to help shape and expedite change, and it recognizes the importance of collaborating with overseas and foreign investors to speed development," says Mok.

Operating in China presents many opportunities, but is fraught with challenges and obstacles. Doing your homework, proceeding cautiously, and enlisting help where needed can help ensure success.

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