Logistics Industry in China. August 2013!"#$%&"'(#)''%*#+),,($)#-)%.)#+/)

Logistics Industry in China August 2013!"#$%&"'(#)''%*#+),,($)#-)%.)#+/)

Table of Contents Introduction... 2 Industry overview... 3 Logistics industry demonstrates robust growth... 4 Total logistics costs stay high... 6 Logistics enterprises foresee favourable prospects... 7 Competitive landscape... 9 Logistics concentration remains scattered... 10 Leading logistics players scale up... 12 Foreign expansion accelerates in most segments... 13 Market snapshots... 14 Production logistics demand up in lower-tier cities... 15 Growth of online retail market and challenges on nationwide distribution go hand-in-hand... 17 Express delivery firms step into online retail... 21 Rail transport reform enhances logistics capabilities in China... 23 Heavy taxes for some logistics companies... 25 Government support for logistics development... 26 Challenges... 29 Warehousing management has room to grow... 30 Logistics burden of high toll fees... 31 Stringent regulation hinders logistics growth... 31 Constraints on human resources... 32 Conclusions and Implications... 33!

Logistics Industry in China Introduction China s economic growth has been accompanied by the ever-increasing demand for logistics services. However, the country s logistics capabilities still remain at an early stage of development, with a number of unresolved challenges. That said, foreign and local players continue to expand into the logistics market, and the government is pushing to improve logistics capacity and efficiency. Accordingly, we believe the logistics sector is set to maintain a steady and robust growth over the coming years. In this report, we take an overview of China s logistics sector and assess the competitive landscape of the logistics market. We also review the industry s latest developments and major challenges. "

# Industry overview

Logistics Industry in China Logistics industry demonstrates robust growth Driven by the demanding industrial sector and widening domestic retail market, China s logistics industry registered robust growth in 2012. Total logistics value 1 reached 177,300 billion yuan, up by 9.8% year-on-year (yoy) in real terms (see Exhibit 1). Composition of total logistics value The manufacturing sector remains key to China s economic development. As a result, the logistics value of industrial products accounted for an overwhelming 91.4% share of the total value last year. Following up, the logistics value of agricultural products, imported products, recycled materials and commercial and personal products in 2012 recorded yoy growth of 4.5%, 7.8%, 10.2% and 23.5%, respectively. Exhibit 1 China s total logistics value by category 2011 2012 Billion yoy % Share Billion yoy % Share yuan growth in total yuan growth in total Total logistics value 158,400 12.3 100 177,300 9.8 100 Including: - Agricultural products 2,600 4.5 1.6 2,900 4.5 1.6 - Industrial products 143,600 13.1 90.2 162,000 10.0 91.4 - Imported products 11,200 4.3 7.0 11,500 7.8 6.5 - Recycled materials 600 20.4 0.4 700 10.2 0.4 - Commercial and personal products 200 18.3 0.1 200 23.5 0.1 Source: China Federation of Logistics & Purchasing Logistics demand coefficient The logistics demand coefficient, the logistics industry s value-to-gdp ratio, was 3.4 last year, up from 3.0 in 2008 (see Exhibit 2). Such evidence indicates a steady growth in China s logistics market. 1 According to China Federation of Logistics & Purchasing, total logistics value is defined as the total value of products being produced in or entering the country during the recorded period. $

Exhibit 2 Logistics demand coefficient, 2008-2012 Source: China Federation of Logistics & Purchasing Total value-added of the logistics industry Total value-added of the logistics industry reflects the size of the market. The larger the value-added, the larger is the market. In 2012, value-added of the logistics industry was 3,500 billion yuan, recording a yoy increase of 9.1% (see Exhibit 3). Also, both the share of total value-added of the logistics industry in China s tertiary sector and GDP in 2012, remained stable at 15.3% and 6.8%, respectively. Exhibit 3 The logistics industry s total value added Unit 2010 2011 2012 Total value-added billion yuan 2,700 3,200 3,500 % yoy growth % 13.1 13.9 9.1 Share in GDP % 6.9 6.8 6.8 Share in tertiary industry % 16.0 15.7 15.3 Source: China Federation of Logistics & Purchasing %

Logistics Industry in China Total logistics costs stay high China s total logistics costs amounted to 9,400 billion yuan in 2012, up by 11.4% yoy. Exhibit 4 shows the breakdown of total logistics costs from 2008 to 2012. Of this figure, transport costs accounted for the largest share; however, the proportionate figure has been decreasing over the past few years. On the other hand, the ratio of total logistics costs to GDP was 18.0% in 2012, down from 18.1% in 2008 (see Exhibit 5). But the ratio is still almost twice that observed in other developed countries. Exhibit 4 Total logistics costs and composition, 2008-2012 Share in total logistics costs 2008 2009 2010 2011 2012 Management 12.7% 11.8% 12.7% 12.0% 12.8% Inventory 34.7% 32.9% 33.8% 35.0% 35.1% Transportation 52.6% 55.3% 53.5% 53.0% 52.1% Source: China Federation of Logistics & Purchasing Exhibit 5 Total logistics costs as a percentage of GDP, 2008-2012 Source: China Federation of Logistics & Purchasing &

Logistics enterprises foresee favourable prospects The China Logistics Prosperity Index (LPI) 2 is newly established and was launched by the China Federation of Logistics and Purchasing (CFLP) in March 2013. The data is compiled from survey responses by nationwide logistics enterprises regarding their logistics activities and inventory levels of the current month, along with their business expectations for the following three months. Exhibit 6 shows the monthly results of the LPI and sub-indices. The LPI came in at 52.4 in July, remaining in expansionary zone for four consecutive months. The index indicates steady growth in logistics activities 3. Also, the business volume index was 56.9 in July, up from 55.5 in June. The figure reflects a moderate demand for logistics services. In addition, the investment in fixed asset index was 52.3 in July. The reading shows that logistics enterprises have continued to increase their investment in fixed assets, implying an optimistic business outlook. This is in line with the business expectations index, which remained high at 57.2 in July, showing that many enterprises in the logistics industry still foresaw good business over the following three months. 2 China Logistics Prosperity Index (LPI) is a newly established index providing an early indication each month of logistics activities in the Chinese logistics sector. The first LPI was launched in March 2013 by the China Federation of Logistics & Purchasing (CFLP). The Fung Business Intelligence Centre is responsible for drafting and disseminating the English LPI report. For more detail, visit the monthly LPI reports at http:// www.funggroup.com/eng/knowledge/research.php?report=lpi_monthly 3 A LPI reading above 50 indicates overall expansion in the logistics sector; below 50, there is overall contraction. '

Logistics Industry in China Exhibit 6 China logistics prosperity index, LPI (April July, 2013) LPI and sub-indices April May June July LPI* 54.8 53.2 53.1 52.4 Business volume 57.1 55.8 55.5 56.9 New orders 54.9 53.1 54.6 52.3 Average inventory 49.7 49.3 53.1 51.3 Inventory turnover 51.6 50.9 49.8 48.3 Cash flow 53.2 50.2 53.1 51.5 Capacity utilisation 56.5 54.3 51.3 51.5 Logistics services charges 52.7 49.9 49.9 48.1 Operating profit 53.2 51.6 56.1 48.1 Operating cost 62.9 58.3 58.1 61.7 Investment in fixed asset 55.7 55.3 53.3 52.3 Employment 52.1 50.2 51.0 49.7 Business expectations 61.8 60.6 60.5 57.2 * The LPI is a composite index based on the diffusion indices for five indicators with varying weights: New orders: 30%; Business volume: 25%; Employment: 20%; Capacity utilisation: 15%; and Inventory turnover: 10%. (The diffusion index is the sum of the positive responses plus one half of those responding the same.) Source: China Federation of Logistics & Purchasing and Fung Business Intelligence Centre (

) Competitive landscape

Logistics Industry in China Logistics concentration remains scattered China s logistics market is fragmented, with huge numbers of logistics enterprises of various kinds 4. Road transport enterprises account for the largest share of the logistics market, in terms of the number of enterprises. According to the China Logistics Development Report, published by the CFLP, there was an estimated 790,000 road transport companies in the country last year. The top 20 road transport companies accounted for less than 2% of the market share 5. Indeed, most transporters are small- and medium-sized enterprises and they tend to operate in single or nearby cities. To find more business opportunities, they compete with each other on price, instead of on service quality. By contrast, many large-scale logistics service providers (LSPs) provide in-town transportation services, but also offer all-round logistics services or provide sophisticated logistics solutions. In general, they have substantial logistics resources, comprehensive nationwide networks and refined relationships with the government. Exhibit 7 lists the four significant types of large-scale LSPs in China, including stateowned enterprises, privately-owned enterprises, spin-offs from large-scale manufacturing and retailing enterprises, and foreign players. 4 According to the industrial classification by the National Development and Reform Commission, logistics enterprises in China include various kinds of transport companies (rail, road, water, air and pipeline), freight forwarders, warehouse operators, and postal and express delivery companies. 5 China General Chamber of Commerce, Newsletter on Economic and Commerce, Issue 14, 2013.!*

Exhibit 7 Four major types of large-scale logistics enterprises in China and selected examples State-owned Private-owned Spin-offs Foreign-owned Selected examples Annto COSCO Deppon (from Midea) Agility Sinotrans Jiaji Anji (from SAIC Motor) DB Schenker LF Logistics Source: Compiled by Fung Business Intelligence Centre In recent years, the express delivery sector, an emerging segment in the logistics industry, has expanded quickly amid the boom within China s online retail market. According to the Economist Intelligence Unit 6, there are more than 7,500 express delivery firms. Exhibit 8 displays the four major types of express delivery companies. Exhibit 8 Four major types of express delivery companies in China and selected examples State-owned Private-owned Spin-offs Foreign-owned Selected examples EMS SF Express Rufengda (from Vancl) China Air Shentong Express Express Ozzo China Rail YTO Express (from Newegg) Express DHL FedEx TNT UPS Source: Compiled by Fung Business Intelligence Centre 6 Economist Intelligence Unit, China Hand Distribution, 2012!!

Logistics Industry in China Leading logistics players scale up The CFLP released an annual list of top 50 domestic logistics enterprises (the top 50s) 7. In 2011, the total sales revenues of the top 50s reached 727.4 billion yuan, up by 17.5% yoy. The top 50s registered annual sales revenues of over 2 billion yuan in 2011. Exhibit 9 shows the top 20 domestic logistics enterprises, ranked by sales revenues in 2011. Exhibit 9 Top 20 domestic logistics enterprises by sales revenues 2011 Ranking Ranking (billion % yoy in 2011 in 2010 Logistics enterprises yuan) growth 1 1 China Ocean Shipping (Group) Company 161.6 12.5 2 2 Sinotrans & CSC Holdings Co. Ltd 99.1 8.2 3 3 China Shipping (Group) Company 62.8 (2.2) 4 4 Xiamen Xiangyu Group Co. Ltd 33.9 31.9 5 5 China Railway Material Group Co., Ltd 26.7 17.8 6 6 China National Materials Storage and 26.3 17.8 Transportation Corporation 7 - Kailuan Group 22.6-8 - Tianjin Port Group 22.1-9 9 China Petroleum Transportation Corporation 21.5 47.4 10 8 Henan Coal and Chemical Industry 20.2 24.8 Group Co. Ltd. 11 10 S.F. Express (Group) Co., Ltd 15.2 33.1 12 - Lianyungang Port Logistics Co., Ltd 14.4-13 - Fujian Provincial Communication 12.7 - Transportation Group Co., Ltd 14 11 China Railway Container Transport Co. Ltd 12.4 16.9 15 13 Shuohuang Railway Development Co. Ltd. 10.4 8.1 16 - Expeditors International Inc. 9.8-17 - Gaogang Port Integrated Logistics Park 8.6-18 - China Railway Material Company Limited 8.4-19 - China National Petroleum Corporation 8.2-20 16 China Railway Express Co. Ltd 8.1 5.3 Source: China Federation of Logistics & Purchasing 7 CFLP, China Logistics Development Report, 2012-2013!"

Foreign expansion accelerates in most segments Foreign LSPs possess sophisticated logistics technology, funding, professional expertise, as well as a comprehensive international network. They have significant advantages when providing international logistics and express delivery services. Also, they have the capabilities to fulfill specific logistics demands, including automobile logistics and cold chain logistics. As compared with local LSPs, foreign LSPs are superior in providing value-added logistics services to meet international and local requirements of discerning clients in China. International express delivery services are an example. International companies, such as DHL, FedEx, TNT and UPS, account for 80% of the market share in China s international express delivery market 8. They have global network coverage, linking China with the world, and provide reliable and efficient delivery services for high-value orders. To further deepen their coverage and develop their local logistics business, UPS and FedEx have obtained local express delivery services licenses as from September 2012. It is expected that the moves will pose major challenges to the domestic, high-value express delivery market in China. Having said that, overseas players are not able to dominate all logistics market segments, particularly highly-regulated rail cargo logistics and pharmaceutical logistics, and the newly-emerging e-commerce logistics segments. To a relative extent, China state-owned logistics enterprises have a comprehensive network across the country and close contact with the state itself. They have advantages in highly-regulated logistics segments. By contrast, domestic, private-owned logistics enterprises can provide cheap and efficient delivery services that are acceptable to pricesensitive clients. These firms dominate the domestic e-commerce logistics market 9. 8 China Merchants Securities, Report of China s Express Delivery Industry, 2012 9 http://www.kpmg.com/cn/zh/issuesandinsights/articlespublications/newsletters/kpmg-industry-updates/ Documents/Industry-Update-1303-02-c.pdf!#

Logistics Industry in China Market snapshots!$

Production logistics demand up in lower-tier cities Over recent years, the steep hike in labour and production costs in coastal areas has prompted some manufacturing enterprises to migrate their factories from key cities in coastal areas to inland, lower-tier cities. Many enterprises, such as Foxconn, Flextronics, Dell, HP, and Pfizer 10, have established new plants or relocated coastal facilities. As many manufacturing plants are scattered across different cities and counties, relocation is reshaping the industrial supply chain. Many relocated manufacturing enterprises outsource their logistics activities to lower-tier cities to regional LSPs, which possess local know-how and have closer ties with local regulatory authorities and customs. However, services quality and logistics capabilities may not always be up to standard; very often, local LSPs fail to comply with expected requirements. Due to the mixed performances of LSPs in lower-tier cities, many relocated manufacturing enterprises need to reassess their inventory policies and schedule extra buffer times for production and distribution (see Box 1). Having said that, some regional LSPs, which are capable of fulfilling sophisticated production logistics demands, have now emerged. A number are logistics spin-offs from large-scale manufacturing groups, as outlined in the previous section. For example, Annto Logistics in Anhui province and Zhongpin Logistics in Henan province used to be logistics arms of an home appliance group and an agricultural food processing corporation, respectively. They turned into independent logistics entities, serving their group s clients, and handling outside orders. This type of regional LSPs provides nationwide logistics services and now plays an increasingly important role in the production logistics segment. 10 http://www.joneslanglasalle.com.cn/china/en-gb/pages/newsdetail.aspx?itemid=20740!%

Logistics Industry in China Box 1: Outsourcing practices by industrial enterprises in China Due to mixed performances by LSPs, many enterprises in China are reluctant to outsource all their logistics activities to third parties. Hence, many LSPs handle only some low-end logistics tasks for their principals. According to a survey conducted by the National Development and Reform Commission (NDRC) and Nankai University in 2012 (Note 1), traditional functions such as transport and distribution were the most popular services outsourced by surveyed industrial enterprises. For those logistics functions that required more sophisticated technique, such as inventory management, product assembling and logistics system design, the outsourcing rates were less than 15%. The figures reflect industrial enterprises reluctance to outsource high value-added logistics services to LSPs. Types of logistics services outsourced* 2009 2010 2011 Transport and distribution 80.9% 90.9% 86.7% Packaging and processing 13.5% 14.6% 21.7% Warehousing 15.5% 16.3% 20.8% Logistics information management 15.6% 16.2% 18.0% Sourcing management - - 15.7% Logistics systems design 10.7% 11.5% 14.6% Product assembly - - 13.3% Inventory management 5.4% 5.9% 8.3% * multiple responses allowed The following table shows key concerns of surveyed industrial enterprises when making their outsourcing decisions. LSPs poor service quality and high service charges were the major concerns. Major concerns on outsourcing Ranking Service quality of the LSP 1 Service charges of the LSP 2 Loss of control in logistics management 3 Quality of human capital of the LSP 4 Warehouse system integration and maintenance 5 Differences in corporate culture and logistics systems 6 Staff reallocation of the principal 7 Note 1: The 10th National Survey on Logistics Market was conducted between January and May 2012 by the NDRC and Nankai University. Different sets of questionnaires were distributed to industrial and commercial enterprises (survey 1) and logistics enterprises (survey 2). A total of 865 valid responses were received (survey 1:287; survey 2:436) Source: National Development and Reform Commission and Nankai University!&

Growth of online retail market and challenges on nationwide distribution go hand-in-hand Chinese consumers are increasingly taking to shopping online. As urban and rural household incomes in lower-tier cities increase rapidly, the growth momentum of the online retail markets in these cities are set to accelerate, even ahead of the growth in higher-tier cities. According to mainland online giant Taobao, the annual growth rate of online shoppers in Anhui, Henan, Shanxi, Shaanxi and Xinjiang provinces exceeded 100% in 2011, while the growth in some coastal areas, such as Shanghai, Zhejiang and Guangdong, was less than 70% yoy 11 (see Exhibit 10). Shoppers in lower-tier cities spent an average of 5,628 yuan online in 2012, while their counterparts in higher-tier cities spent 4,700 yuan during the same period 12. Exhibit 10: Annual growth of online shopping users by province (2011 compared to 2010) Source: Taobao and CTR, compiled by Fung Business Intelligence Centre 11 http://finance.qq.com/a/20120410/007317.htm 12 http://www.scmp.com/business/china-business/article/1293202/smaller-chinese-cities-lead-way- shiftonline-shopping!'

Logistics Industry in China Unlike key cities, many lower-tier cities and counties are remotely situated across the country, with dispersed populations. So, for numerous online retailers, it is costly to extend their distribution networks to lower-tier cities. Without economies of scale and sufficient transaction volumes, many online retailers avoid investing heavily in sophisticated logistics infrastructure in these remote areas. Also, delivery locations for online orders are not limited to points of sale, further complicating the delivery process and adding uncertainties to retailers investment decisions. Take online purchases of electrical appliances as an example. Increasing numbers of Chinese consumers enjoy the convenience of door-to-door delivery and so purchase electrical appliances online. Some online shoppers in higher-tier cities not only purchase goods for their own use, but also shop for their parents or relatives living in lower-tier cities. Since points of sale and delivery locations may not be the same, the frequency of the average online shopping exercise in a particular region may not truly reflect actual retail demand and the need for local logistics support. Thus, inventory management and product fulfillment spanning the country become great challenges for many online retailers. To fulfill orders across the country, online retailers commonly adopt a hybrid approach, with their own logistics facilities and trucking teams serving key cities. As for more remote areas, they outsource their logistics services to LSPs and express delivery companies (see Box 2).!(

Box 2: Logistics approaches by key online retailers; the China Smart Logistics Network draws attention China s online retail market is rapidly expanding from coastal cities to lower-tier cities and counties in inland areas. However, with fragmented logistics continuing to hinder online retail development, some large online operators have developed their own nationwide logistics plans, which they have recently revealed. In May 2013, Jack Ma, founder of Alibaba group, together with some property companies and logistics partners, developed the China Smart Logistics Network (CSN) logistics system (Note1), aiming to support seamless information transfers between vendors, online operators and LSPs. CSN now aims to provide nationwide 24-hour delivery within the next five to eight years. Another leading online retail operator, JD.com (previously known as 360buy), is also aiming to build a nationwide logistics infrastructure network. The firm has six large logistics centres and over 900 distribution stations nationwide. Since November 2012, it has started to open up a warehouse management system for its vendors in phases 1, aiming to allow information synchronisation and streamline logistics processes between stakeholders. The table below summarises the latest logistics developments by key online retail operators: Online retail Logistics establishments and distribution services operators Taobao Taobao has its own logistics system linking its central warehouse system to those of its merchants and third party logistics partners All third party logistics partners must comply with Taobao s logistics requirements and standards Taobao does not provide a courier team but outsources delivery services to third parties JD.com JD.com has set up warehouses in key cities in China, including Beijing, (previously Shanghai, Guangzhou and Chengdu known as The firm expects to build between 50 and 60 warehouses across the 360Buy) country over the next three years and set up its own courier teams in the coming three to five years!)

Logistics Industry in China Online retail Logistics establishments and distribution services operators Amazon.cn Amazon.cn has 11 warehouses in major cities, including Beijing, Suzhou, Guangzhou and Chengdu The firm has its own delivery teams serving 19 cities, but also partners with third party couriers to cover the rest of China Yihaodian Yihaodian has logistics centres in Beijing, Shanghai, Guangzhou, Wuhan and Chengdu. The firm has more than 130 delivery centres, serving 34 cities Yihaodian s In-house delivery team handles 70% of the products it sells, while the rest are distributed by third party couriers Newegg Newegg has its own logistics company, Ozzo Logistics, to provide services for itself and external customers Ozzo Logistics has 21 logistics centres in key cities in China, including Beijing, Shanghai, Guangzhou, Wuhan and Chengdu Currently, Newegg provides delivery options to online shoppers, including 24-hour delivery services in 10 major cities, and self pick-up services Ozzo Logistics is to gradually outsource its distribution services to LSPs and focus on logistics management Mecox Lane Mecox Lane has set up logistics centres in major cities, including Beijing, Shanghai, Guangzhou and Chengdu The firm does not have its own delivery team but outsources delivery services to more than 170 third party couriers, including EMS Vancl Vancl has its own logistics company, Rufengda Rufengda has set up a delivery network in 20 cities, including Beijing, Shanghai, Guangzhou and Chengdu For the rest of China, Vancl outsources delivery services to third party couriers Note 1: The CSN project is managed by Cainiao Network Technology Co., Ltd. (Cainiao), a company formed by Alibaba Group, Intime Group, Fosun Group and five major Chinese courier companies, including S.F. Express, Shentong, Yuantong, Zhong Tong and Yunda. The project aims to set up warehouses across the country and build a database system tracking trade and delivery information; it is expected to be open to manufacturers, online sellers, delivery services and third party service providers to help build an end-to-end chain, allowing 24- hour deliveries across China. Source: 1 http://big5.xinhuanet.com/gate/big5/news.xinhuanet.com/fortune/2013-06/23/c_116254667.htm, Companies websites, Fung Business Intelligence Centre "*

Express delivery firms step into online retail Amid the rapid growth of e-commerce in China, demand for domestic express delivery services has soared over the past decade. In 2012, express delivery companies handled more than 25 million orders per day in China, of which around 60% was generated by online retailing 13. However, due to fierce competition and high operating cost in China, express delivery companies have generally lower profit margins (see Box 3). Also, as shown earlier, increasing numbers of online retail operators have set up their own logistics infrastructure and networks, posing a greater challenge to express delivery companies. As a result, some large-scale express delivery firms featuring nationwide coverage have tried to diversify into online retailing. Box 3: Profit margins of Chinese logistics enterprises According to the previously mentioned survey by the NDRC and Nankai University, 43.9% of surveyed logistics enterprises recorded profit margins of 5-10%, while 41.2% indicated profit margins of 0-5% in 2011. The average profit margin was 5.59% in 2011, slightly higher than the previous year. Overall, logistics enterprises profitability in China is still low. A heavy tax burden, high toll fees, expensive fuel costs and rising wages are trimming the profit margins of logistics enterprises. Source: National Development and Reform Commission and Nankai University 13 Source: http://www.chinawuliu.com.cn/zixun/201303/12/213647.shtml "!

Logistics Industry in China For instance, Yuantong Express, S.F. Express and Shentong Express set up their own online retail platforms in 2008, 2010 and 2012, respectively. However, their online businesses were not sustainable even over a few months because they faced head-tohead competition from existing online retail operators. Also, their failure was attributed to low online traffic volumes, limited online orders, uncompetitive product offerings online, and lack of clear market positioning. To establish sustainable online retail businesses and differentiate themselves from online competitors, express delivery companies need to invest in product sourcing, online retail marketing and customer services, (see Box 4). Box 4: The case of S.F. Express Despite its failed attempt to become an online retail operator in 2010, S.F. Express established another online retail platform, sfbest.com, in mid-2012. This targets the highend food market, selling foods for festival occasions, fresh and chilled foods, wine and other drinks, and health foods. Its door-to-door cold chain delivery service is available in Beijing while its last mile delivery services for non cold-chain goods cover Beijing, Shanghai, Guangzhou, Shenzhen, Tianjin, Hangzhou, Suzhou, Nanjing and Wuhan. The question is what motivated S.F. Express to re-enter the online retail market and focus on the high-end food market. We believe the reasons are twofold: Growing demand for high-end food products Food hygiene and safety issues in China have prompted consumers to seek better quality foods from secure sources. The online food retail platform provides transparent information with higher traceability. In parallel, increasing numbers of Chinese consumers prefer a healthy diet. They are willing to spend more on high-end and organic foods, so there is huge market potential for selling such food products online. Hands-on experience providing door-to-door cold chain delivery S.F. Express has specific experience handling cold chain products, while providing door-to-door cold chain delivery services to other online retail operators. It has more than 140 refrigerated trucks 1 and cold storage facilities in Shanghai, Guangzhou and Shenzhen. Most online merchants selling cold chain goods on Taobao are reportedly using S.F. Express services 2. Source: 1 http://www.chinawuliu.com.cn/zixun/201307/22/241755.shtml 2 http://home.ebrun.com/blog-35826.html ""

Rail transport reform enhances logistics capabilities in China The State Council announced its plan in March 2013 to dismantle the Ministry of Railways (MOR) to form administrative and commercial arms. As shown in Exhibit 11, railway administration functions are to be supervised by the Ministry of Transport (MOT), while the newly formed China Railway Corporation (CRC) is to be responsible for all commercial activities. Exhibit 11 Dismantling the Ministry of Railways Administrative arm Dismantling of standards railway project quality Supervised by Ministry of Transport Ministry of Railways Commercial arm transport management Newly established China Railways Corporation Source: Compiled by Fung Business Intelligence Centre It is expected that restructuring will enhance China s logistics capabilities, as rail, road, water and air transport are managed and monitored under the same umbrella, the MOT. Integration should remove barriers against developing inter-modal transport between rail and other transport modes. In terms of freight transport management, the MOR was previously responsible for bulk cargo businesses, such as coal, minerals and grain. However, due to the economic downturn and lower demand for coal, railway freight services also experienced shrinking demand. In addition, complicated cargo-handling procedures and inefficient services further slowed railway cargo demand. So, to boost the railway cargo business, the newly formed CRC implemented a series of measures on 15 June 2013 (see Exhibit 12). Immediately after the implementation of cargo reform, an increase in rail cargo traffic in certain regions was evident. For instance, from 15 June to 9 July 2013, the CRC in Guangzhou generated an increase of high-value product cargo volumes by 10% yoy 14. 14 Shipping Gazette, Daily Shipping News, 22 July 2013 "#

Logistics Industry in China Exhibit 12 Railway cargo reform in China Simplifying cargo handling procedures Expanding business scope Launching door-to-door services In the past, when customers applied for rail freight delivery slots, they were required to submit cargo plans to several divisions of the MOR and pay for handling charges to various departments at different rates, resulting in complicated and lengthy application procedures Now, cargo plan is no longer required. Handling charges are standardised. In addition, customers can arrange cargo delivery through a hotline or online platform, in addition to counter services Aside from bulk cargo businesses, the CRC has also deployed more resources for handling high-value products and daily necessities The CRC has introduced rail courier services In the past, high-speed rail without passenger carriage was solely used for daily systems checking. Now, the first non-passenger train on selected lines is used to transport small parcels, accompanied by technical checks. Examples are the Harbin- Dalian and Beijing-Shanghai lines The first intercity express service between Shanghai and Hefei was launched in early July 2013, and the cargo handling time was trimmed from 23 hours to nine Formerly, only station-to-station services were available Now, cargoes can be picked up at railway stations or delivered to designated points, subject to customer requests. In accordance with their service pledges, station-to-station and door-to-door delivery orders are fulfilled within two and three days, respectively Source: http://cv.ce.cn/kcz/wlys/201307/01/t20130701_24528972.shtml & http://www.chinawuliu.com.cn/ zixun/201307/16/240231.shtml "$

Heavy taxes for some logistics companies The Ministry of Finance and the State Administration of Taxation jointly issued a circular in November 2011 outlining the implementation and transition rules of a pilot tax reform with Value-added Tax (VAT) to replace Business Tax (BT). The objective is to reduce double taxation caused by separate VAT and BT charges and enable a fairer VAT input deduction system. The reform is regarded as one of the key measures to promote the development of China s services sector. The pilot programme was rolled out in Shanghai on 1 January, 2012. It focused primarily on transportation, as well as six other modern services sectors (see Exhibit 13). VAT rates for the transportation and logistics auxiliary services sectors are 11% and 6%, respectively. By July 2012, the programme was subsequently extended to Beijing, Tianjin, Jiangsu, Zhejiang, Anhui, Fujian, Hubei and Guangdong provinces. In April 2013, the State Council announced that the VAT pilot programme would extend nationwide and cover further services sectors on 1 August 2013 (see Exhibit 13). With the nationwide extension, the competitive advantage available to the nine pilot cities and provinces were removed. A more level playing field should also benefit transport and logistics industries. The State Council has indicated that the railways, post and telecommunications industries will be covered by the VAT pilot programme in the near future. "%

Logistics Industry in China Exhibit 13 VAT pilot programme Transportation Modern services sectors services sector Effective from Road transport Research, development and technical 1 January 2012 Water transport services Air transport Information technology services Pipeline transport Cultural creative services Logistics auxiliary services Certification and consulting services Tangible, movable property leasing services Effective from Production, broadcast and publication 1 August 2013 of radio, films and television programmes Source: Compiled by Fung Business Intelligence Centre Whether or not tax reform is entirely beneficial to the logistics sector remains to be seen. Despite a significant reduction of tax in the pilot cities and provinces concerned, some transport and logistics companies actually report increases in their tax burden. This is because transportation services do not offer many opportunities for companies to claim input VAT credits. Take the following cases, for example: Salaries and toll fees are ineligible for input VAT credit; If a truck is refueled from the cities excluded from the VAT pilot programme, the fuel costs are not eligible for input VAT credit; Input VAT credit can be claimed by reference to official VAT invoice. However, many logistics companies failed to obtain the official invoices from small-sized companies. Government support for logistics development Realising that the logistics industry is critical to economic success, the government has put in place a number of supportive policies in the past few years. Exhibit 14 shows some major government initiatives that support the development of China s logistics industry. "&

Exhibit 14 Major government policies related to the logistics sector Date Launched by Name of Policy Key highlights Tax Policy for Bulk Commodity 50% reduction of current urban land use tax Storage Facilities of Logistics will be applied to the land for bulk commodity Enterprises ( storage facilities owned by logistics enterprises (whether self-used or leased out) to the area of land for storage facilities exceeding 6,000 sqm SPB Accelerating the Collaboration business environment for the collaboration and and Development of Express development of express delivery services and Delivery Services and Online online retailing. Retailing ( ) Support industrial collaboration and development, in terms of financial and taxation incentives, and supply of land and human capital Promote seamless information sharing and standardisation among the two industries Introduce a credit system to monitor the performances of express delivery companies and online retail operators Encourage express delivery companies to establish logistics facilities and services in line with the needs of online retailing counterparts Explore win-win strategies to strengthen business collaboration between the two industries, e.g. forming strategic alliances, mergers and acquisitions. Enhance business security, e.g. track and trace delivery systems, establish emergency handling procedures for the two industries, strengthen information security systems to prevent information leakage Promote information technology (IT) adoption, e.g. support the development of the Internet of Things, encourage the use of Radio Frequency Identification (RFID), personal digital assistants (PDAs) and global positioning systems (GPS). Council on Further Reformation of the distribution system, reducing the ratio of total logistics Distribution Sector and costs to GDP, enhancing the competence of large- Acceleration of the Development sized distribution enterprises, adopting modern of the Distribution Sector information technologies, and improving the market ( environment with policy and regulatory support. Strengthen the distribution network such as the urban-rural transport, in-town delivery Optimise the design of supply chain network Improve logistics facilities, e.g. large-sized distribution centre, agricultural cold chain facilities Enhance the level of informatisation in the distribution sector, e.g. adopting the Internet of things, cloud computing, GPS and e-barcodes the Industrial Upgrade of the services from performing traditional storage functions to Warehousing Sector ( providing sophisticated warehouse management and ) operations Support the development of one-stop-shop warehousing services, covering inventory management, value-added services, and pick and pack "'

Logistics Industry in China Date Launched by Name of Policy Key highlights Promote IT adoption, e.g. the Internet of Things, barcode and RFID Align standardisation levels, in terms of warehouse layout design, services, equipment and evaluation criteria Encourage collaboration of warehousing resources via mergers and acquisitions, strategic alliances, outsourcing and e-platforms Renovate traditional cold storage facilities to suit the needs of modern cold chain logistics and Information Technology on logistics, so as to improve the efficiency of logistics Accelerating Informatization on management and operation Logistics ( ) Develop and standardise informatised logistics systems for various parties, e.g. government departments, logistics companies, industrial and commercial corporations and the army Improve the level of logistics informatisation by various government departments, in terms of service standards and management Improve the level of informatisation of logistics industry and logistics companies Improve the level of informatisation of industrial and commercial companies, and the standard of supply chain management Standardise informatisation systems in logistics Accelerate cooperation of army-civilian informatisation systems in logistics, so as to improve the efficiency of emergency logistics Promote and develop the innovative use of IT in logistics Concerning the Regulation of the development and management of the express delivery Express Delivery Industry market ( protected by law regard to business entities, delivery services, safety, control and management, and legal responsibilities MOHRUD, Improving the Management of management of urban distribution by setting up a MOPS, MOT, Urban Distribution ( comprehensive regulatory system, improving NDRC and SPB ) infrastructure and facilities, enhancing transport management and traffic control, strictly enforcing the law, and promoting IT adoption and the State Administration of levying value-added tax in lieu of business tax in Taxation on Pilot Plan for Levying Shanghai and eight other provinces in 2012, the pilot Value-Added Tax in Lieu of plan rolls out nationwide, effective from August 2013 Industry and Some Modern Services modern services sectors, the pilot industries also cover Industries across the country production, broadcast and publication industries for ( radio, films and television programmes ) Notes: MIIT: The Ministry of Industry and Information Technology; MOF: The Ministry of Finance; MOFCOM: The Ministry of Commerce; MOHRUD: The Ministry of Housing and Rural-Urban Development; MOPS: The Ministry of Public Security; MOT: The Ministry of Transport; NDRC: The National Development and Reform Commission; SAT: The State Administration of Taxation; SPB: State Post Bureau Source: Various government websites; compiled by Fung Business Intelligence Centre "(

") Challenges

Logistics Industry in China Warehousing management has room to grow Many warehouses owned by local LSPs in China are relatively sub-standard. Furthermore, poor warehouse layout design and insufficient material handling equipment always affect the efficiency of warehousing operations. Manual work is still common in small-sized warehouses. Poor warehousing and inventory management have led to long average inventory periods. According to the survey mentioned earlier and conducted by the NDRC and Nankai University in 2011, more than half the surveyed industrial enterprises and 49% of commercial enterprises held their inventories for more than one month (see Exhibit 15). In addition, some warehouse operators that do not adopt warehouse management systems fail to synchronise inventory data with their stakeholders in a timely manner. Without transparent information flows, warehouse operators cannot respond quickly enough to their clients. Exhibit 15 Average inventory period of industrial and commercial enterprises Industrial enterprises Commercial enterprises Average inventory period 2010 2011 2010 2011 <10 days 9.5% 9.0% 14.8% 15.0% 10 20 days 11.2% 9.5% 23.9% 19.0% 21 30 days 23.7% 23.0% 18.6% 17.0% 1 2 months 32.4% 32.5% 25.7% 29.0% > 2 months 23.2% 26.0% 17.0% 20.0% Average (days) 45.9 48.1 38.0 41.6 Source: National Development and Reform Commission and Nankai University #*

Logistics burden of high toll fees Today, road transport remains the major freight transport mode in China. In 2012, around 78% of cargo was dispatched by road, in terms of tonnage (see Exhibit 16). It is noteworthy that road tolls account for about one-third of transport costs in China 15. Excessive highway tolls, as well as price hikes of fuel and labour, have eaten into many logistics enterprises profits. Exhibit 16 Freight traffic in China (million tonnes) 2010 % of total 2011 % of total 2012 % of total Road 24,481 75.5 28,201 76.3 31,885 77.8 Rail 3,643 11.2 3,933 10.6 3,904 9.5 Air 5.6 0.02 5.6 0.02 5.5 0.01 Water 3,789 11.7 4,260 11.5 4,587 11.2 Pipeline 500 1.5 571 1.5 612 1.5 Total 32,418 100 36,970 100 40,994 100 Source: National Bureau of Statistics of China To reduce average transport costs, trucks are typically overloaded. Road accidents occur easily and roads are often blocked for clearance. Severe traffic jams also undermine any guarantee of on-time delivery and affect the service quality of logistics operators. Stringent regulation hinders logistics growth Although the government has promulgated a number of measures to support the development of the logistics industry, policy execution sometimes hinders that growth. Licensing applications comprise one example. Logistics companies have to apply various types of operating licenses to set up nationwide businesses. However, licenses are issued by different provincial governments, while application charges and procedures vary from province to province. Due to the complexity in dealing with numerous parties, some logistics companies lose their impetus when attempting to develop inter-regional business. 15 http://www.chinairn.com/news/20130603/163442977.html #!

Logistics Industry in China In addition, many local governments impose specific requirements on logistics operations. For instance, they adopt stringent rules over in-town trucking services, due to considerations of city traffic control and environmental issues. Also, quota for the number of in-town trucking licenses granted to trucking firms are fixed. Those logistics operators who failed to get proper licenses could either have to pay higher costs to hire licensed trucking firms to convey the goods, or operate without licences with a risk of being fined. Added to these, operational flexibility can be affected by restricted loading or unloading zones, roadblocks and restrictions on the types of trucks allowed into towns. Constraints on human resources Insufficient supply of logistics manpower has long been a major concern in China, despite the fact that the number of graduates in logistics and transport studies has been increasing in recent years. Labour shortages also lead to higher turnover rates in a competitive labour market. Besides, many local practitioners lack understanding of modern management and the skills to satisfy increasingly demanding clients. Many foreign companies have set up their businesses in China and sought out LSPs with local experience. However, while representatives of local firms usually have hands-on operational experience, many cannot communicate with potential clients in foreign languages. Then again, some staff are welleducated but lack the relevant experience and soft skills. #"

## Conclusions and Implications

Logistics Industry in China Without doubt, the logistics industry in China is robust in its growth. However, it still faces many challenges. Numerous small-sized LSPs offer similar but limited services without nationwide coverage, while the supply of logistics facilities in some districts are either insufficient or redundant. Also, constraints on logistics facilities and human capital, as well as expensive logistics costs, add further burdens to logistics users and operators. Below are some tips for running logistics business in China. Work closely with stakeholders via real time information sharing Streamline operational processes, so as to minimise logistics costs Follow government policies and incentive schemes Logistics Enterprises in China Select competent and reliable partners Retain logistics talent Constantly upgrade facilities #$

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