China's effort to improve the standard of living in the hinterland has manufacturers following.

We’ve seen the TV commercials touting the expediency of China’s shiny new and sleek high-speed passenger trains rushing through a lush, green environment. But what we don’t see is the inferior, inefficient freight rail system or the chaotic traffic jams on Chinese highways that can slow down a company’s supply chain by days.

Clearly, China is a work in progress relative to the transportation and logistics infrastructure required to support industrial development slowly shifting to the country’s interior to take advantage of cheaper labor and numerous incentives. Multinational manufacturers need to think holistically about how far west they should consider going to establish a manufacturing facility that makes sense economically and logistically.


 

Land of stark differences

China is roughly the same size as the United States-with a distance of about 3,000 miles separating its bustling eastern coastal region from the desolate mountainous and arid west bordering what is called “the ’Stans”: Kazakhstan, Kyrgyzstan, Tajikistan, and Pakistan. There are a few investments in this region in resources like oil, natural gas, and mining. The far-western provinces of Xinjiang and Tibet are unforgiving and barren, so the Go-West territory is really focused on China’s interior-as far west as Chongqing, about 800 miles west of Shanghai (roughly the distance from New York City to Chicago).

Northern China-called ‘the rust belt’-is an area in the province of Manchuria where steel and coal industries settled during the 1950s and 1960s, notes Chris Runckel, president of Portland, Oregon-based Runckel & Associates (www.business-in-asia.com). “Much of that development was state-owned and operated inefficiently,” he reports. “Consequently, much of that activity has begun to fade.” The area is defined by desert, although there is a good amount of wheat and agricultural activity to support the area’s economy.

Southern China has seen a lot of investment, primarily in Guangdong province. “The Hong Kong Chinese invested heavily in that area in manufacturing toys, shoes, and textiles,” Runckel reports. “However, a lot of that investment is moving further inland to remote sections of Guangdong or Guangxi because the region is becoming too expensive in world terms.”

Interior China-the region home to the Go-West campaign-had been primarily an agricultural economy with many poor people who had been migrating for years to coastal manufacturing centers in the east. As multinational companies began establishing manufacturing facilities in the interior, migrant workers no longer had to leave their homes to travel east to find work to support their families. Instead of working in the east for most of the year-returning home only for two weeks during the Chinese New Year-they discovered they could put their factory skills to good use right in their own backyards.

While significant investments were made in the 1980s and 1990s on the eastern seaboard to support foreign trade, China’s interior lagged and stagnated, says Runckel. “So there was a pronounced difference between the standard of living for coastal Chinese and those living in the interior-and this divide caused serious complications among people.” The Go West program is an attempt to narrow that divide.

China today boasts the world’s second-largest economy, after that of the U.S. “This is a significant achievement for the country,” notes Pilar Dieter, director for Alaris Consulting-China, based in Shanghai. “One of the challenges China will have going forward in becoming an economic super-power is to provide all Chinese access to opportunities to purchase material goods, to become educated, and to acquire wealth. This is the undercurrent of the Go West program.”


 

Westward with eyes wide open

The Go West campaign began around 2000 to improve the mostly impoverished lives of residents in the interior. Multinational companies originally settled in China’s coastal eastern region to take advantage of cheap labor and raw materials there. “They established in places like Shanghai, Beijing, and Tianjin because exporting from these cities is easy,” Dieter says. “But now labor in these regions is skyrocketing, so the motivation that originally brought multinational companies to China is getting diluted.”

To grasp what was beginning to happen on the east coast as a result of the manufacturing shift to the interior, take a look at a typical factory which might run as many as three shifts a day, with about 4,000 employees per shift. As manufacturing companies began locating in the interior, migrant workers from the interior no longer needed to travel east to work. So coastal factories, once employing upwards of 10,000 employees, began to face a labor shortage. If labor was available, workers were demanding higher salaries as they recognized their worth in the global economy.

Realizing that multinational companies were evaluating moves to more cost effective places like Vietnam and other Southeast Asian countries, yet wanting to keep that manufacturing base in China, the Peoples Republic of China government began to tout China’s interior as a viable alternative. The government began encouraging provinces in this region to attract manufacturing operations by offering lures like tax incentives and attractive real estate rates, which were no longer available on the east coast. “The provinces worked with their cities showing the most promise,” explains Dieter.

Runckel cautions not to overstate the magnitude of this shift. “You can see the trend and the government has succeeded in shifting more investment into the region. It is creating an economic landscape making more and more Chinese and foreign investors want to consider the west as a possibility.”

Interior provinces began conducting aggressive promotional campaigns to entice industrial development within their respective provinces. “You find that different provinces target which manufacturing sectors they want to attract,” Dieter says. “For example, one province might want to attract biomedical, while others want heavy industry or alternative energy enterprises. A lot of this also depends on the resources available within provinces. If you are a pharmaceutical company, you will not want to move to a major steel manufacturing hub along the Yangtze River delta just because the area offers great tax incentives. You will want to locate close to a university with strong research facilities and universities with strong medical programs.”

On the surface, all of these activities sounded plausible. But then problems began manifesting themselves, especially when it came to getting goods out of the interior and to the coastal ports. First of all, movement from province to province is troublesome, and not at all like traveling from state to state here in the U.S. “Many people think of China as one country, but in reality it is more like a series of small, local provincial markets that can challenge transporting goods from one province to another,” explains Runckel.

For instance, a trucker traveling from Chongqing in the interior to coastal Shanghai has to travel through about four provinces. “The 3PLs are experiencing difficulties,” reports Dieter. “Some trucks don’t have a license to drive in certain provinces, so they have to transfer all the product from one truck to another at a provincial border. The process is very complex and this has been a long-standing challenge to manufacturers. It is the government’s way of trying to control traffic in how product is being transported. They want to keep certain vehicles from going into certain territories to protect a particular territory’s trucking economy. We expect to see some changes in this practice at some point.”

Many 3PLs enter the country asset-light and look for partners or they sub-lease and handle contracts with the shipper themselves, Dieter explains. “Logistics was one of the last industries to be allowed into the Chinese economy within the last several years. Before that, any foreign logistics company could only enter China through a JV (joint venture). That has changed and foreign companies can set up wholly owned foreign enterprises and operate independently. But, you have to make sure you have the right trucks and the right licenses to be able to do what you need to do because not all trucks are allowed in certain city limits.” Adding to the complexity are the excessive duties and toll charges imposed on drivers traveling from one province into another.

Shaanxi province-offering a large population of potential workers-is an example of a success story in terms of Chinese and foreign investments, notes Runckel. In addition to the provincial incentives to locate there, the Chinese government is making significant investments in the infrastructure to support the westward manufacturing shift.




 

The infrastructure

About 80 percent of all cargo is transported over the road by truck, so the highways are a critical link for manufacturers to get products to the ports for export. The highway network in China is known as the National Trunk Highway System and is the world’s second-longest, about 40,500 miles long, after the U.S. network. Most roads in the network are toll roads, financed primarily by private companies under contract from the provincial governments. Although many of the major arteries are new, they are beginning to be abused, notes Dieter. “Overloaded trucks pose significant threats to the physical road and to bridges. Consequently, you see continuous construction as roads are repaired and maintained.” She adds that although there are weight regulations in place, the challenge lies in enforcement and interpretation, which takes place at the provincial level.

Readers might recall hearing about the recent 60-mile-long traffic jam on National Expressway 110 that lasted about nine days. This major highway has been undergoing a series of construction projects, some of which caused the traffic jam that resulted in significant kinks in the supply chains of numerous manufacturers moving product to ports on the east coast. Part of the problem, reports Dieter, is that this highway was not constructed wide enough to be able to handle the amount of traffic that travels it. “So the construction projects began and the result was they made a bad situation much worse.” A number of these remedial projects were to have been completed by this past September.

Rail freight transport is not as mature an industry as it is in the U.S. Trucks are the major source of transport because of the poor rail infrastructure into interior provinces. Although the rivers play a role in transport, shippers usually have contingency plans to accommodate exceptionally low or high river levels. “The quality of the rail bed from the western provinces to the east is so poor that trains have to travel at a slow rate,” Runckel explains. He adds that the new high-speed passenger rail network uses a new rail bed that is used only for that network. Although there is virtually no intermodal transport, there are plans to establish the infrastructure to support intermodal within the next five to 10 years. “I think the government will help encourage this,” adds Runckel. “China has some real logistics challenges, and unless they go to solutions like intermodal, I don’t see how they will solve these transportation and logistics problems.”

There is still a lot of work to be done because the rail system was in such poor condition, continues Runckel. “There is no set date for the completion of the freight rail system. Only recently has the government begun to invest more into the freight transport system and that, in large part, is due to complaints by many foreign investors who decided to move inland on the promise that the infrastructure would be there for them. But those broken promises have discouraged many companies, who were counting on the logistics network to make their investments work out economically.”

Relying on rail is not prudent for shippers at this time, adds Dieter. “Rail transport historically has been controlled by the government,” she says. “This means that if there is a massive power outage in Beijing, the government could choose to use rail to move coal east so people there will have the fuel they need for heat. So any military contingency or initiative deemed to be for the good of the people take precedence over commercial shipments.”

Runckel reports that since 1999, the Chinese government has invested about $320 billion on 120 major infrastructure projects in the poor interior areas. “Much of this occurred as part of the stimulus that the Chinese government rolled out in 2008 in response to the worldwide recession. In 2010 alone, the Chinese government says it will invest in excess of $100 billion for infrastructure projects including roads, railways, airports, nuclear power stations, coal mining, and construction of power grids to these interior areas.” Most of this work is being done in Chongqing and other ‘west’ areas.

These projects are considered long-term. “But they build these projects faster than the U.S. or Europe because they don’t have to conduct any environmental impact studies, nor do they have to deal with permitting processes, which speeds up these large projects,” explains Runckel. “They work three shifts a day and what might take ten years in the West to build, they can complete in about two years.”




 

Due diligence

Companies with a China presence might be considering expansion into the interior. “It’s critical for companies to do their homework,” cautions Dieter. “Just because there is this Go West buzz does not mean it’s the right thing for every company. Companies need to evaluate on all levels what they are trying to achieve in a China expansion. This will help define whether or not going west works for them and, if so, in which city they need to be.”

In consulting with companies considering a China presence, Runckel and his associates advise that going west can decrease their labor costs significantly. “Often you can qualify for incentives, but your logistics costs can actually rise considerably because logistics costs into and out of the interior are not cheap. There are also intangible costs involved such as increased transportation time and problems meeting departure dates. Your shipment times will also increase and it’s a lot more difficult to deliver on time to the ports, especially if you have to travel through areas of road construction. You need to take all of these things into account.”

Even with all the challenges facing companies, they are still deciding to make the move. “Many are looking to the future and they want to be in the interior to serve the growing Chinese domestic market,” Runckel says. “By reducing their costs moving inland and by getting into position to serve the internal market, they are hoping they will gain as China continues to advance economically. But, some companies are still finding that the markets are not quite there yet. This means they will face a period of difficulty before they get to a position where they begin to benefit from the move.”

Although the interior is increasingly becoming attractive, Runckel notes he is not convinced it is ready to offer the benefits multinational companies are seeking. “Many companies will discover it is not quite right for them today and that they still need to be in the Shanghai Delta region for the next several years until some of this infrastructure actually gets built, and particularly once the interior freight rail system comes of age.”

Despite the confusing pros and cons facing companies, Runckel points to a success story. “Shaanxi province over the last year has had growth of about 13 percent, compared with 8 percent GDP nationally. They were able to achieve this by attracting a wide range of industries including energy projects, equipment manufacturers, a limited number of high-tech, and a substantial number of infrastructure construction projects.”

Runckel reports that recently, the government helped promote the development of the airline industry in Xi’an, the capital of Shaanxi province. The city also has a high-tech zone and a large software industrial park. “Before this, you never saw these industries that far inland, with most of these industries located in the coastal areas. So this is an example of what could be coming attractions and how interior cities can be very successful in supporting a range of industries.” wt



Contributing writer April Terreri writes frequently on a variety of transportation and logistics issues.