‘Going Out’ for logistics know-how
As China develops interior and urbanizes, its need to improve transport grows.
Look for an increase in investment in and acquisitions of logistics companies by the Chinese in coming years, said Richard Gluck, a partner at Washington law firm Garvey, Schubert and Barer (GSB).
Gluck is outside general counsel to the Transportation Intermediaries Association (TIA), the largest U.S. trade association for third party logistics companies in the United States. In 2012, TIA and the Chinese International Forwarders Association signed a memorandum of agreement to cooperate with each other and help members promote business by learning best practices and removing barriers.
Anticipated investment by the Chinese in the U.S. logistics industry is just beginning to happen, Gluck said, and was one of the motivations last year to form a new group called the Sino-American Logistics Council.
Stanley Barer, a founder of GSB, and Qian Yongchang, former minister of communications and first chairman of COSCO, were named honorary chairmen of the group at the 6th Annual Sino-American Logistics Conference in October.
Qian told the conference “the logistics industry in China has entered a stage of orderly and rapid development. However, generally speaking, China's logistics industry is still in a primary stage of low level, has weak foundation and a small scale; the level of multimodal transportation is low, logistics enterprises are mostly small, scattered, and poorly managed, the degree of organization and integration of logistics services are still not high. As the logistics industry is still in its primary stage of development the total logistics cost still accounts for a high ratio of 18 percent to GDP, with a 0.2-0.3 percent decrease each year.”
According to an Asian Development Bank study, that’s nearly twice the 9.3 percent logistics cost to GDP ratio in the United States. Furthermore, the bank noted China’s logistics costs amounted to 25-30 percent of total product cost compared to 5-7 percent in the United States, 5-10 percent in Europe, and 10-15 percent globally.
Gluck recently completed a one-year fellowship at Harvard University’s advanced leadership initiative which studied relations between the United States and China, and specifically what can be done “to help China develop a more mature logistics industry mainly for the social benefit of people,” for example, by cutting pollution from transportation, reducing food spoilage and improving food safety.
“One of the things that I’ve been interested in and that the Chinese are interested in is deepening the collaboration between the logistics industry in China and the U.S.,” he said during an interview at his Washington office.
GSB has long experience in both transportation and U.S.-China relations. Barer negotiated the resumption of shipping service between China and the United States in 1979, and the law firm has long represented COSCO in the United States.
Gluck noted one of the themes of China’s 12th Five-Year Plan, which came into force in 2011, is “Going Out,” a policy to encourage investment in the United States and Western Europe, as opposed to earlier investments in Africa and other less developed parts of the world, largely for natural resources.
Daniel Rosen, a partner at Rhodium Group, which tracks Chinese investment closely, wrote “China has gone from a trivial position to top three in terms of outbound global direct investment in little over half a decade. Its stock of external direct investments will rise from less than $500 billion today to $2.5-$5 trillion, most likely, in the coming decade.”
The 12th Five-Year Plan included a call to “accelerate the establishment of a socialized, specialized, and informational modern logistics service system, vigorously develop third party logistics.”
Gluck said the Chinese “are trying to invest some of the accumulated capital they’ve got in the more developed economies like the U.S. and Western Europe.” As an example, he pointed to the acquisition last year of the pork producer Smithfield Foods by Shuanghui International Holdings.
Rhodium said the $7.1 billion Smithfield deal accounted for about half of Chinese foreign direct investment in the United States last year.
Thilo Hanemann, research director at Rhodium, said there are “large pools of capital” in China held by private investors, sovereign wealth funds, and insurance companies that have a need to invest overseas in assets with long-term, relatively stable returns.
Transportation infrastructure in the United States, including port projects, may be attractive to those investors, he said.
He said companies could also benefit from providing some of the materials used in infrastructure, noting Chinese firms supplied steel used in the San Francisco-Oakland Bay Bridge.
In addition, Chinese firms are interested in companies offering actual transportation services, and Hanemann pointed to the long presence in the United States of container lines COSCO and China Shipping.
Chinese customers want to get closer to U.S customers and that’s likely to require investment in U.S. logistics services, he added.
Until recently, the Chinese value chain has been mostly limited to manufacturing, but Hanemann suggested that model is coming to an end, in part, because of rising labor and energy costs in China.
Chinese companies are “moving up and down the value chain to capture other areas of profit, and one is by moving closer to the customer and building out wholesaling, distribution and retail businesses,” he explained.
Hanemann said this is happening on a modest scale already in the furniture and textile industry, and the Chinese have other U.S. manufacturing sectors in their sights, adding SANY, the construction equipment manufacturer, built a factory in Georgia; Lenovo, a computer maker, started manufacturing in North Carolina; and Wanxiang bought the battery manufacturer A123 last year and in January looked likely to buy bankrupt electric car maker Fisker.
Some of those companies, like Lenovo, have located in the United States to react to consumer preferences more quickly, he said. Others like Haier, which makes air conditioners and refrigerators, are doing so partly to satisfy the desire for Chinese consumers who see “made in America” as a sign of quality.
Gluck said one of the purposes of China’s “Going Out” policy is to “bring in know-how to benefit the Chinese people. The idea of Going Out is not just to penetrate foreign markets but it’s also to bring back best practices, technology, know-how so you can kind of leapfrog the process of developing your own internal domestic economy.
“If you think of historical analogies, it’s maybe similar to Meiji Japan or Russia under Peter the Great, and they actually studied those historical models. The idea is rather than trying to figure out how to do this on our own, if the Americans or the Europeans are already doing it better than we are, borrow their best practices and then adapt it to the Chinese situation,” he said.
Hanemann, who agrees with Gluck, said “one of the major motivations for Chinese companies to invest in the U.S. is to gain access to knowledge and technology.”
A primary focus of China between 1979 and 2000 was development of exports, to become “factory to the world” and modernize its cities.
Gluck said since 2000 there has been a growing emphasis on development of Western China, including cities such as Chengdu and Wuhan. Wuhan, he noted, has been designated as a key inland logistics hub.
China is “pivoting toward development of the domestic economy because they realize that they can’t drive growth forever by increasing exports and the recession of 2008 really taught them a lesson about being overly reliant on exports,” he said.
China also wants to close the gap in the standard of living between its people living in the Eastern coastal cities and those in the countryside, in part by urbanizing the population and moving about 250 million people into cities to improve their access to health care, education, and housing.
“There is also some question whether they can generate enough food with these small plots of land to feed a growing population,” Gluck said. “So they feel they have to introduce modern methods of agriculture which means consolidating these small plots and introducing yield management and that sort of thing.”
The Asian Development Bank said “logistics inefficiencies in the agricultural sector are among the main factors causing low returns to farmers, high and volatile food prices, and degraded quality of food supplies” in China.
“Improved agriculture logistics are particularly important with regard to perishable agricultural products,” the bank said. “As much as 30 percent of fruit and vegetable production is lost due to spoilage during transportation, storage, and wholesale and retail activities.”
The bank noted “to compensate for spoilage, farmers rely heavily on chemical fertilizers, pesticides, and other inputs to raise crop yields.”
Agriculture logistics could become even more important as expansion of the middle class and increasing urbanization results in growing demand for perishable agricultural products of high quality and value.
These changes are “calling for a whole different focus for the logistics industry… because the story up to now has been to create an export flow. Now it is moving stuff around inside China,” Gluck said.
In the preface to a policy study published by the Asian Development Bank in 2012, Dai Dongchang, chief planner for China’s Ministry of Transport, said “the current logistics system still has significant shortcomings regarding its efficiency, safety and sustainability. These are constraining the country’s economic development and therefore need to be resolved.”
The bank’s report noted circumstances that help explain the generally higher cost of logistics in China, such as the distance between interior sources and coastal production centers, difficulty serving rural populations, and that Chinese goods have “a higher weight-value ratio, which results in a higher transport cost relative to total product cost compared to other countries.”
The bank looked at the different components of logistics cost: transportation, inventory, and management. In China, transportation accounts for a smaller portion of overall logistics costs because of heavy competition by road carriers, and lax government supervision which allows Chinese truckers to resort to excessive driving hours, extreme overloading, and illegal equipment modifications, the Asian Development Bank said. It also noted China’s trucking industry passes on internal costs to society through “excessively high accident rates, destruction of road, services, and high levels of pollution.”
Gluck said there’s strong interest in China for clean technology, because trucks are the second largest source of greenhouse gas emissions in the country after coal-fired power plants.
Short-haul truckers frequently return home empty, while long-haul truckers average 7-10 days for backhauls, the Asian Development Bank said, which results in average wait costs of $110-$157.
Citing a 2010 World Bank study, the bank said while China rates well when compared to other countries for both its infrastructure and international traffic, it was under par for customs processing, cargo tracking and tracing, timeliness and logistics competency.
“This reflects the need to improve its management systems, information technology and logistics competency,” the Asian Development Bank said. Western expertise in these areas could make investment in or acquisition of U.S. firms attractive.
While investment diversification and a desire to penetrate U.S. markets with Chinese brands account for some of that drive, Gluck believes the desire to bring back knowledge “is really the strongest” motivation.
At the Sino-American Logistics Conference in October, he said attendees included Chinese businesses and government officials who “had been invited for the purpose of matching people on the China side who had the need, with people on the U.S. side who had the know-how,” as well as investment advisors and consultants.
“We were trying to encourage the Chinese to tell us what their needs are, and some of them actually came forward with some very interesting ideas for what they’re looking for,” he said.
“What we’re trying to do with the Sino-American Logistics Council is move beyond having conferences and showering people with information to helping them frame what their actual needs are and then match them with the resources on the U.S. side who can meet those needs,” said Gluck.
After the 2006 controversy over the effort by DP World to acquire management contracts for terminals in U.S. ports, is the U.S. logistics industry open and ripe for Chinese investment?
“I think so,” said Gluck. “I don’t think the Chinese are really trying to come in and take over the American logistics system. I think China’s focus is on developing its own country. They have a billion people whose standard of living they need to raise, I think it’s a misconception to think they are coming here to try to insinuate themselves into our transportation infrastructure and the next day we’ll turn around and find a Chinese toll collector on the Pennsylvania turnpike. I just don’t think that’s where their heads are.
“I think there’s a lot of receptivity both to Chinese investment and I also think there is money out there that is interested in investing in Chinese companies and in joint ventures between American and Chinese companies to develop the infrastructure in China,” he added.