Tech company overcomes logistics challenges to support new inland factories.
By Eric Kulisch
Hewlett-Packard’s decision four years ago to move a chunk of its personal computer manufacturing operations to central China from the Shanghai region, on the coast, was made possible by the adoption of innovative transport routes and a greater focus on social and environmental responsibility, according to a top company executive.
Tony Prophet, senior vice president for HP’s $65 billion printing and personal systems unit, explained the rationale behind the tech giant’s relocation decision and the resulting benefits during a presentation at an Aug. 28 forum on the importance of modern supply chains to economic growth hosted by the Center for Strategic and International Studies in Washington.
HP lost $8.9 billion in the third quarter and experienced a 5 percent decline in revenue from the year ago period as consumers flocked to tablets and smartphones instead of personal computers. Despite sagging sales, HP is still the world’s largest maker of printers and personal computers. Its size and global reach naturally mean it is one of the largest users of international freight transportation in the world.
Every 60 seconds, HP delivers 120 PCs and 100 printers to customers. That translates to 110 million cartons shipped per year. On any given day, HP transports the equivalent of four to five fully-loaded Boeing 747-400 cargo planes. Its annual ocean volume is 80,000 TEUs. The Palo Alto, Calif.-based company spends more than $3 billion each year to move all those products.
In the past decade since its merger with Compaq, HP has significantly reengineered its manufacturing and logistics network to deal with changing market needs and labor costs. The tech giant has shrunk the number of final assembly sites around the world from 85 to less than 30, closing operations that were in close proximity to each other or in high-cost locations. Many plants – either company-owned or belonging to third-party manufacturers - that were geared to making PCs had to be converted to produce smaller notebooks that are popular today.
Since fiscal year 2009, it has also reduced its supplier base by half to 1,174, slashed its transportation and distribution nodes from 558 to 414 and streamlined information technology 49 percent by retiring 159 legacy systems.
HP is the first multinational company to make PCs in Russia, where it has a joint venture in St. Petersburg, and in Turkey, and is expanding into northern India.
But Prophet stressed that HP’s manufacturing strategy isn’t solely based on finding the lowest-cost regions for production. Many sites are chosen because of a desire to be closer to customers in a particular region. HP, for example, still builds PCs in Indianapolis for corporate customers such as the U.S. government and manufactures servers in Houston, he said. The computer company also has a plant in Tokyo, one of the most expensive areas in the world to live and work.
HP takes into account the total delivery cost, from production and logistics to duties and taxes, when making site-selection decisions, he added.
HP assembles PCs in many places around the world because the machines are expensive to transport and local production reduces distribution costs. Notebook manufacturing is concentrated in a few locations because the lightweight devices are easier to transport.
In the greater Shanghai area, HP and its suppliers have many factories clustered together in a tight area that belongs to a free trade zone. The production cluster allows efficient synchronization of inbound material flows and finished components to HP, and the nearby Shanghai International Airport serves as an expedited gateway for finished notebooks. A small portion of the notebooks produced are moved by sea through Shanghai’s seaport.
HP officials, however, realized that by having so much production concentrated in one location the company was susceptible to labor disruptions and shortages, Prophet said.
Early each year, companies in China shut down for at least a week or more for the Lunar New Year holiday, but then face high absenteeism rates when not all the workers return from vacation, and labor inflation as they raise pay to attract workers to return. Most of China’s export manufacturing is concentrated along the eastern coastline, but a large number of employees migrate from cities and rural areas to central and western China. During the holiday, they pile on trains and flock home to visit their families.
In recent years, there has also been labor unrest at many contract manufacturers in the electronics and auto industries over pay and working conditions.
Many companies have responded to rising wages in China by moving production to other low-cost countries in Asia, or other regions. Others, like HP, are moving some manufacturing activities to China’s interior. At the same time, the Chinese government made it a top policy priority to urbanize and industrialize western regions of the country. To attract businesses, the central and provincial governments have offered tax breaks, low-interest financing, infrastructure investment and even housing for workers.
In 2009, HP decided to diversify its PC operations and move further inland. The company now makes PCs and servers in Shanghai, PCs in the east-central city of Wuhan, printers in coastal Shenzhen, and in central Chongqing it makes PCs for the domestic market and PCs and printers for export.
The shift in production pattern also changed the company’s logistics dynamics.
For one thing, freight rail and highway infrastructure in central regions were not fully developed or connected to the national network in the East, and there is no motor carrier that provides nationwide service. Barge service tends to be too slow or unavailable more than 800 miles inland. These factors, along with the extra distance involved, result in higher logistics costs for export cargoes.
Creative logistics approaches have paved the way for HP’s Chongqing operation to flourish the past three and a half years, Prophet said. The company essentially created new trade lanes that did not exist before.
In late 2010, HP arranged the charter of its first 747 freighter to carry products to Europe and the following year it developed a “new silk road,” or land bridge. The Trans-Siberian railroad was not a good option because it goes too far north and then all the way across Russia. Instead, HP worked with the Chinese, Russian and Kazakhstan rail ministries, and German railroad Deutsche Bahn, to start a new overland route.
As of late August, HP has run 33 dedicated trains from Chongqing to Europe. The 42-car block trains each carry 100,000 PCs and run once a week. HP also established a rail link to the coast for computers and printers exported by ocean to Europe or the Americas.
Developing rail links from Chongqing was critical because HP wants to reduce its use of air transport as much as possible to shrink its carbon footprint, Prophet said.
HP calculates that air freight is 57 times more carbon-intensive than ocean transport, while rail produces twice as much carbon per unit shipped than ocean, and trucking is 72 times worse.
“Our strategy is to take the products as much by sea as possible, get them to a port as close to the customer as possible for notebooks, and for desktops to build them as close to the customer as possible. And then, where we can’t move by sea, we move by rail and where we can’t move by rail, we move, as a last resort, by air,” Prophet said.
Today, HP transports 60 to 70 percent of its notebooks by air, compared to 90 percent in 2009.
HP’s sea lanes are primarily to Latin America, the ports of Rotterdam and Hamburg in Europe, and Long Beach and Oakland in the United States. But, Prophet said during the question period, the desire to use ports that are closest to sales points has triggered a reevaluation of HP’s import gateways.
HP is studying the possibility of using all-water transport through the Panama Canal for the first time to bring product to Houston. In Europe, Rotterdam and Hamburg are good locations for transatlantic trade, but not ideal for cargo from Asia, Prophet said.
HP is also exploring the possibility of shipping product through Southern European ports such as Marseilles in France, Barcelona, and primarily Piraeus in Greece. Another option is Malta, where cargo can be transshipped to smaller vessels to feed European ports, he said.
The challenge is these ports lie in countries with different tax regimes that don’t have liberal policies like those existing in The Netherlands, Belgium and Germany for deferring Europe’s value-added tax. The VAT in Europe is about 20 percent of the import value.
Importers typically have to pay VAT when they buy goods and then apply for a refund when they sell them. The refund can take months to process. In the Netherlands, for example, payment of the VAT can be delayed from the time of import and paid when the company declares taxes, usually monthly. Under this account-based method, companies only pay the net VAT after the sold inventory is included in the calculation. Germany allows companies to pay the VAT on a periodic basis. Postponing VAT payments has a big impact on cash flow and is a big reason cargo flows to Rotterdam and Hamburg, Prophet said.
HP’s sustainability policy is aimed at reducing the company’s impact on global warming. In addition to minimizing air transport, HP is believed to be the first major technology company to measure the carbon footprint of its extended supply chain, Prophet said. HP operations produce about 1.9 million metric tons of carbon per year, while its manufacturing and logistics vendors have a combined carbon output of about 3.5 million metric tons.
Taking a snapshot of the greenhouse gas emissions serves as a good baseline for driving year-over-year improvement, he added.
The computer maker exclusively uses U.S. motor carriers that are SmartWay-approved by the U.S. Environmental Protection Agency. SmartWay is a voluntary, market-based program that uses incentives to get trucking companies to increase their fuel efficiency and anti-pollution measures. Shippers in the program, like HP, commit to move at least 50 percent of their freight with SmartWay carriers.
Other ways HP exhibits environmental responsibility is by recycling more than 2 million tons of material in the United States and reducing its use of materials that could be hazardous to human health. And its move to central China, says Prophet, can be seen as part of its effort to be socially responsible.
The plant relocation has reduced the reliance on migrants who face the stress of being away from their families and coexisting in communal living areas with people from around the country who speak different dialects, are used to different food and have different traditions.
We decided “that instead of seasonally putting people on trains we’d put the PCs on trains,” he said. In Chongqing, about 85 percent of the employees now live within an hour or two of the factory, which, along with competitive wages, has reduced absenteeism rates. Meanwhile, the government is providing modern dormitories with cooking and recreational facilities that meet HP’s standards, Prophet said.
The facilities could become a model for the rest of the nation, he added.