The global economic explosion triggered when China joined the W.T.O. in 2001 continues to reverberate. Retail and manufacturing supply chains have been transformed as shippers seek out Chinese opportunities (currently the source of 3% of all U.S. retail goods).

As output keeps growing, the movement of goods has become a critical concern to traders. If it remains relatively easy to ship overseas, transporting goods within the country can pose problems. With more critical nodes in global supply chains originating in China, internal bottlenecks there constitute a dangerous exposure.

The state has announced it will build seven comprehensive transportation hubs in the industrial Yangtze River Delta to handle the distribution of goods. China's highways will reach 2.3 million kilometers by 2010,according to official plans. There are equally big plans to expand railways.

But as Jun-Sheng Li, Chairman and CEO of Transplace, the logistics management software provider points out, this kind of progress, important as it is, constitutes only the first stage of what's needed. "This is the 'hardware'," he says. "If you talk about linkage of sources of shipment to U.S. markets, there remains a lot of work to do." There's more need for integration between the various players: manufacturers, transporters to hubs and ports, and then ocean transportation. "Bottlenecks are more due to management capacity than infrastructure."

Not surprisingly, major global logistics providers are broadening their presence there to fill voids in the logistics networks their customers cannot afford:

• In a move aimed at strengthening its China network, UPS recently signed a Memorandum of Understanding with Shanghai Airport Group which will lead the company to create an internatiol Air Hub at Pudong International Airport in 2007. UPS also announced the introduction of domestic express service in China. (www.ups.com)

• ProLogis, a worldwide leader in warehouse facilities, plans to invest $1.25 billion by 2009 in mainland port cities. (www.prologis.com)

• Yellow Roadway Corp. is developing a joint venture with China's second largest freight forwarder (JHJ International Transportation), in order to pursue Chairman Bill Zollar's vision of "seamless end-to-end global solutions." (www.yellowroadway.com)

• Transplace opened a Shanghai office two years ago. "If any of our customers say 'I want my vendors to start inputting visibility of shipment while in China'," explains Transplace Chairman-CEO Jun-Sheng, "we can get a user set up." (www.transplace.com)

In following their customers to China, the logistics sector is responding to special circumstances there. Distribution inland remains fragmented among small, local providers and there is little integration across transportation modes. Costs are high, delays common.

When North American manufacturers and retailers analyze opportunities in China, it is easy not to see beyond the cost advantages in labor and material. But getting those goods to where they need to be can be challenging. This special report appraises the current state of Chinese logistics and how it fits into the integrated global supply chain. -Neil Shister, Editorial Director

Competitive Advantages of China Go Beyond Labor

Higher value chain integration than U.S. plants and more ability to control component costs distinguish Chinese manufacturing.
By Jim Maurer

A recent study of U.S. and Chinese manufacturers shows that Chinese plants are more likely to report value chain integration than their U.S. counterparts, reports the accounting, tax and business advisory services firm, Grant Thornton LLP, in The China Vision: Opportunities and Challenges for U.S. Manufacturers, a white paper created to provide analysis and insight for U.S. firms competing against, doing business with, or in China.

According to the white paper, Chinese plants more often report "extensive integration" with suppliers (29% vs. 11%) and customers (33% vs. 16%). Among plants in China and the United States, development of an extensively integrated supply chain-downstream with customers and upstream from suppliers-correlates with better performances for a wide array of measures.

"In a era of manufacturing when nearly every product is being viewed as a commodity that can be made virtually anywhere in the world, being tightly integrated with customers puts a manufacturer in position to more readily provide 'total solutions' that extend well beyond 'merely' a product," says Jim Maurer, managing partner of Grant Thornton's Consumer & Industrial Products practice. "Similarly, unless your suppliers feel like integrated partners, covering your back helping you deliver that solution to customers, it is difficult to succeed."

Today, understanding a customer's current and future needs, particularly the requirements of business and industrial customers, requires integration. Integration involves real-time sharing of knowledge, physical assets, human resources, planning and forecasts, and, when necessary, intellectual property-both up and down the chain.

The China edge
Being well integrated with customers not only strengthens a supply chain against competition, but also fortifies the position of the supplier within that chain. The more deeply customers rely on suppliers, the more likely that relationship will endure. Chinese plants, particularly joint ventures/foreign enterprises, appear particularly adept at this integration, in part because their customers, formally or informally, hold an equity stake. U.S. plants that fail to fully integrate with their supply chain partners, including those that are taking some or all of their own operations overseas, could permanently lose their places in many supply chains.

So why is it that Chinese plants report a higher level of integration along their supply chains? Is it the innovative business practices of an emerging economic giant or the result of a historically centrally controlled market?

"Our anlaysis in the China Vision white paper found that, generally, the higher-performing plants in China were joint ventures and foreign enterprise facilities. The state-owned plants and private plants, many of which have only recently been privatized, continue to grapple with decades of antiquated practices," says Grant Thornton's Stephen Chipman, central region managing partner, a United Kingdom native and longtime expatriate to Europe, the United States and Asia. "For example, nearly all [90%] of the JVs and foreign-enterprise plants were integrated with customers, and 40% reported extensive integration. JVs and foreign operations are indeed more integrated, in part because they are more 'Western' in their approaches and these plants are generally newer and more modern as a result of recent opportunities in China for such structures to emerge. They're also more integrated because their customer is often their parent or partner firm. Either way, it's an advantage that is only being diluted, in some cases, by logistics challenges and miles."

The cost advantage
China plants are more likely to control the cost of components and materials from their suppliers than U.S. plants, with 75% of U.S. plants reporting that costs had increased in the past year vs. 51% of Chinese plants. While the underlying study did not specifically ask what drives the Chinese plants' ability to control supplier costs, some of this may be due to government subsidies of petroleum, metal and basic materials. And, here too, many supplier plants may be operating under the same JV umbrella.

While U.S. plants took on higher component and material costs, they were also more likely to pass on those costs to their customers. Almost half of U.S. plants (49%) had raised the price of their primary product in the past year vs. just 29% of Chinese plants. With a 10 percentage-point advantage in gross margin, it's easier not to pass along price increases. It will be interesting to observe the impact of product pricing in China as production costs begin to rise (labor, material and components, etc.) or if the recent revaluation of the yuan has some influence.

It's important to note that many U.S. manufacturers are being pinched. Just 56% of those that experience cost increases for components and materials are able to increase the prices they charge customers. Even so, the 70% of U.S. Census plants experiencing steep supply increases (10% or more) were more likely to transfer those costs.

"China plants having a cost advantage is not news, and the need to push rates out to customers is still not a priority," says Chipman. "Just like the preceding 'new' markets of Japan, Singapore, Taiwan and Mexico, China will face cost pressures. Some of these pressures are now being felt as labor markets tighten. They will become more pronounced if China plants fail to adopt improvement methodologies, such as lean manufacturing, at a pace that matches its Western counterparts. When the world wants your low-cost products, it's easy to run without a lean discipline. When times get tighter, will China plants be able to embrace lean? If so, how quickly?"

What it means for U.S. companies
China plants are less likely than U.S. facilities to outsource manufacturing-centric activities-fabrication, assembly, warehousing-which isn't surprising given the cost advantages they already hold in these areas. China plants were, however, more apt to look for help with some support activities: staging and/or packaging, customer service and purchasing.

Some opportunities still exist for U.S. and other global manufacturers to serve China's need for outsourcing partners in support services, including customer service, information technology management, etc. Companies that participate in China's drive to outsource, though, should be aware of the potential for their China clients to acquire and retain proprietary knowledge-and then end the outsourcing partnership.

"Even against a China that has certain cost and operational advantages, real or perceived, many U.S. manufacturers will continue to survive and thrive," says Maurer. "One way to do so is by taking a 'solution-chain' approach to manufacturing. This approach includes a proactive responsibility and collaboration with its business partners-an approach beyond traditional manufacturing."

"Manufacturers need to follow a simple, but intense strategic plan to provide broad, world-class capabilities to their customers. They must assess the profit-making potential of their business functions (e.g., assembly, purchasing), understand their strengths and weaknesses (e.g., operations superiority, proprietary processes, popular products), identify effective business practices, invest in those, and either improve their weaknesses or outsource to those who can. They then need to manage these internal and external performance functions as one continuous, smooth-flowing, highly productive chain that provides solutions, as well as products to its customers and suppliers resulting in a true, deep integration that can be executed by manufacturers anywhere."

Jim Maurer is the national managing partner for the Consumer & Industrial Products practice of Grant Thornton, LLP, the accounting, tax and business advisory services firm.

To download a copy of Grant Thornton's whitepaper, The China Vision: Opportunities and Challenges for U.S. Manufacturers, go to: http://www.grantthornton.com/content/112797.asp. For more information, please call 866.728.5264 or write cip@gt.com

Contract Manufacturing in China Comes With a Price

Long supply chains and uncertain lead times make responses to shifts in demand difficult.
By Beth Enslow and Kevin Fitzgerald

The rush to source goods and set up contract manufacturing operations in China comes with a price: companies are finding that their costs are higher and lead times are longer than they expected.

A June 2005 study by Aberdeen Group shows that while surveyed companies say they source 21 percent of their total spend from low-cost countries today, they plan to up that to 39 percent within three years.

While the manufacturing cost advantage of China is considerable, many enterprises underestimate the complexity associated with managing China trade. Companies must deal with longer and more unpredictable order cycle times, often 60 days or more. They must manage a labyrinth of customs and logistics requirements to transport their goods. And, they must deal with a supply base that needs hands-on monitoring and support.

"If pricing alone is 40 percent lower, you're probably going to lose about 15 percent of that savings to get the materials to the U.S.," says Dennis Ramussen, director of materials and logistics at Altec, an outdoor equipment manufacturer serving the utility and telecom industries. Customs fees, expediting charges, and higher logistics costs eat into the materials savings.

Companies are looking for ways to improve their China-originated supply chains because lengthy and uncertain lead times make it hard to respond to shifts in domestic demand. They also are seeking ways to minimize the degree of unanticipated supply chain costs. (See Figure below.)

Getting nosy with your Chinese vendors
A lack of visibility and metrics for managing overseas vendors and service providers is the greatest challenge cited by companies doing business in China. "You must have people on site locally to develop suppliers and ensure they can meet contract requirements," says Bill Eagen, purchasing director in Delphi Automotive's Global Supply Management group.

"Companies need to be nosier with their vendors," agrees John Fontanella, senior vice president of supply chain services at Aberdeen. "Research shows that companies that monitor multiple steps with their international vendors have double the success rate of achieving lead time reductions and lower total landed cost. Key monitoring points include raw material arrival at the vendor, major manufacturing steps, shipment status, and customs clearance."

Even the transition from the international to the domestic supply chain is a problem spot for companies; 54 percent of companies say they need to improve their inland transportation management, which can include port processing, drayage/cartage moves, and the inland carrier. Because of port congestion and customs delays, these operators often have to reschedule appointments to pick up freight. Some companies report having to implement 48-hour lead-time buffers for these transitional movements as a result of this unpredictability.

Tellingly, the best performing firms feel least challenged by a lack of timely shipment status information, while laggards feel it is their biggest challenge, says Fontanella. Many of the best-in-class have integrated their systems with the tracking systems of their logistics providers to get automatic status and alert information, while laggards still rely on phone calls, emails, or manual web lookups to track down shipments.

Nearly two-thirds of companies rely heavily on paper and spreadsheet based systems to manage the customs compliance and supply chain aspects of their international orders, according to Aberdeen research. These companies are experiencing a growing performance gap versus more highly automated organizations.

A game plan for China success
Companies can take the following steps to improve the success of their China initiatives:

Optimize facility/supplier location based upon supply chain velocity
Intra-China logistics are immature and delivery performance can be highly variable if the manufacturing facilities are remotely located from ports or in underdeveloped areas. Enterprises must weigh the manufacturing price breaks they are receiving against the added time, cost, and delivery variability that will occur with greater intra-China transit distances or immature logistics infrastructure.

Put in place in-country representation
China trade represents a great opportunity, but manufacturing and logistics performance is still highly variable. The high growth of the Chinese economy, an immature infrastructure, the inability of any contract to adequately convey direction in all situations, and the need to minimize the impact of quality or product shortage issues dictate that enterprises invest in in-country resources to ensure that problems are handled as they occur and at the source. This is particularly critical for enterprises using China manufacturing for the first time or working with new suppliers. Companies report that helping Chinese suppliers ramp up production to the volumes they need is often their greatest challenge, much more so than product quality. Third-party service providers can often help with on-the-ground monitoring and mentoring of vendors.

Sharpen the terms and conditions of manufacturing and logistics services contracts
Many enterprises find that the anticipated manufacturing cost savings do not materialize, because the terms and conditions drive incremental costs beyond the agreed product price. Shifts in demand in either direction or changes to schedule within the order lead-time can rob enterprises of anticipated savings. Enterprises should evaluate the dynamics of their business versus the product price and impact of terms and conditions over the life of the contract to optimize their total cost to procure products.

The same issue exists for managing the cost of logistics services providers. What appears to be low-cost transportation and warehousing contracts can turn out to be the opposite when assessorial charges take effect. Shifts in demand in either direction, as well as manufacturer delays that cause expediting, rob enterprises of anticipated savings. Enterprises should evaluate the dynamics of their business versus the product price and impact of terms and conditions over the life of the contract to optimize their total cost of logistics.

Implement manufacturing and logistics monitoring
Because of the longer lead times of shipping from China, it's important to identify delays, shortages, or quality issues as close to the source as possible. Problems detected at the destination facility are significantly more expensive to address-if possible at all. In addition to tracking the status of individual orders, track operational metrics such as schedule compliance, quality, and dwell time. Leading companies are allocating and redirecting inventory in-transit to meet shifts in demand or compensate for delays. Many companies are also beginning to "port shop"-that is, monitor port congestion before scheduling ocean movements so they can shift to less congested entry points.

Do not come with prepackaged approaches for China
Plans for achieving best practices must acknowledge the realities associated with the current state of China's infrastructure, systems, business practices, and people. This is true in most situations-but because of the gap between China's current state and the best-practice state, best practices employed elsewhere simply may not be achievable in the short term. If the enterprise's China trade involves multiple facilities in multiple regions of China, plan to address manufacturing and logistics variability at a local level. In fact, the quickest route to failure in China may be to assume that experience in other markets will be wholly applicable to China.

Beth Enslow is vice president of enterprise research for Aberdeen Group (www.aberdeen.com) and the author of numerous reports on global trade management and logistics. Kevin Fitzgerald is Aberdeen's vice president of supply management research and the author of low-cost country sourcing analyses.

Calculating Risks in the Chinese Logistics Market

An On-the-Scene Report
By Joel Holland

Despite the great strides the country has made recently through implementing free market reforms, a common sight in China is to see someone manually performing a task that would be highly automated in America...with a mobile phone glued to their ear. The Chinese have and want modern technology, but are operating in a system similar to America in the early 20th century, when industrial plants with huge workforces populated the landscape and polluted the environment.

However, the entrepreneurial spirit pulses through the Chinese character like blood through their veins. More than half a century of Communist central planning has not stymied individual innovation.

It is this confluence of a desire among the Chinese people to become a modern industrial power along with the need for modern management systems and automation to harness this vast potential that provides both the greatest opportunities-and the greatest risks-for North American 3PLs looking for investment opportunities.

It is clearly evident that North American 3PLs, with their increased efficiency and sophistication, can gain a quick advantage over the current labor-intensive Chinese logistics industry. Proper application of the automation that exists in the most rudimentary North American warehouse would reap huge advantages-even in a country where labor is plentiful and cheap. And this advantage should grow further as competition from other foreign corporations pushes up wages and introduces working conditions similar to Western practices.

My belief was strengthened by a tour I took of a "modern" Chinese warehouse; while it was extremely clean and spacious, I couldn't help noticing how many people were milling around on the shop floor. There had to be more than twice the number of workers than in a typical North American warehouse, and almost no racking or forklifts.

All of this indicates that the potential payoff is there for the modern North American logistics industry seeking investment opportunities in China. However, like the popular card game Texas Hold'em, you never know if you possess a winning hand until the final card is turned over. Current wild cards in this gamble for profits are:

• Infrastructure. The nation's infrastructure is developing fast, but there is a marked contrast between highways in big cities, which are very good, with country roads that are narrow and in poor condition. Ports have superior throughput due to the absence of union constraints found at many western ports.

• The Chinese Government. There is a dichotomy between the command/control Communist style of management and the entrepreneurial street vendors referenced above. This contradiction could implode or explode.

• Competition from the Chinese themselves. The Chinese are very hard workers and have a keen sense to emulate others. Domestic Chinese companies will suffer at first as they struggle to compete with foreign companies that offer better wages and working conditions, but when they see the new landscape and make the necessary changes they will be very competitive, if the government permits.

Despite these obstacles, I am cautiously optimistic that North American logistics companies that are willing to make the investment in money, time and people will reap huge rewards from investments in this country of contradictions.

But it's not just the big international players with deep pockets that have more than a gambler's chance to flourish.

Smaller North American 3PLs, who are looking to hedge their bets, have begun opening sales offices in China to build relationships and direct business to their U.S. and Canadian warehouses. The emergence of China as a world economic power has been a boon to the North American 3PL industry at home, creating full domestic warehouses and busy trucking fleets. A host of new business opportunities are waiting in the Far East for companies that can bring modern logistics practices to bear on this vast untapped market.

Joel Hoiland is President and C.E.O. of the Interrnational Warehouse and Logistics Association and can be reached at jhoiland@iwla.com.

Schneider Logistics: A Strategy for Entering China

U.S.-based companies are demanding supply chain engineering.
By Tom Nightingale

"Schneider Logistics is strategically entering China because we are absolutely convinced the country is at an economic inflection point since entering the WTO. Since its [WTO] entry, exports and imports are both growing at a compound annual rate around 25 percent. Simultaneously, we see a lot of consolidation going on in the logistics sector with companies acquiring local partners and entering into joint ventures.

"Currently we're in Shanghai with a representative office, which is an official designation allowing you to establish a toe-hold in the market by locating people there but not allowing for billing of services. We're assessing the opportunities that exist in China for the tools we have to offer.

"It takes a long time to get to this next stage. We moved methodically because we wanted to ensure intellectual property protection, precise timing to minimize risk and synchronous timing with our North American strategy. Intellectual property protection is particularly important to us. Besides our brands and trademarks, our non-asset solutions, such as supply chain engineering, bidding tools and audit payment technology, have to be protected. The logistics industry is a business where your brand and you intellectual capital is the difference between success and failure-and we've worked for over 70 years to build ours. When we eventually deploy our software in China, it can be sitting on thousands of desktops in a matter of weeks. Dispersion of technology can open you up to vulnerabilities.

"Our current hurdle is licensing. While there have been very few surprises, it's been a long, bureaucratic process. We're confident we'll be in full operation by 2006, maybe earlier.

"The first product to the first customer in China will likely be supply chain engineering and consulting services to U.S.-based companies. We're already in conversations with several of them. Moreover, many of them have been pushing us to establish a presence there for years. North American customers have expressed strong interest in connecting our presence in China with our intermodal network through our recent agreement to acquire American Port Services. The biggest thing they want now is supply chain engineering and end-to-end visibility. They want to be able to exert more control on critical nodes in their supply chain to help them monitor freight from point A to point B.

"Our customers include most of the marquee names in retail, who increasingly source directly from China, and are controlling more and more of their supply chains. It's a natural evolution as they phase out intermediary buying agents and vertically integrate. They're going to want supply chain optimization, to know who they're paying and where their goods are at all times. The key is going to be connecting the U.S.-based demand links in the supply chain to the Chinese supply links and fusing them together.

"The biggest challenge in China for logistics providers like us is speed-to-market because everything is evolving so quickly. The first mover who hits the right customers at the right price and at the right time will have some sustainability to their competitive advantage.

"One of the most acute needs now is having the right people on the street who understand the customers' needs and how to knit them with viable, pragmatic logistics solutions. They have to understand both the U.S. and China sides of the supply chain. And, there just aren't many people who have a strong working knowledge of the U.S. and the Chinese transportation network. Like any high-growth market, those kinds of people are hard to find."

Tom Nightingale is Vice President, Corporate Marketing at Schneider National.

UPS Supply Chain Solutions: Establishing Critical Mass in China

Warehouses are key to the network.
By John J. Hafferty

UPS Supply Chain Solutions first came to China in 2001 when UPS bought Fritz Companies, a global freight forwarding company. We moved into integrated logistics from this base. The first stage was getting people on board with in-country knowledge and experience. We're operating on two tracks. One is the external supply chain-goods manufactured in China and shipped overseas. The other is internal within China itself, the domestic market.

The toughest thing about setting up in China has been getting all the required licenses. We have a Class A operating license from the national government, which in other Asian countries would essentially let you operate everywhere. But in China you also have to get authority from each city, which took us almost a year. It's like before deregulation in the U.S. with all the filings. We established our initial network in 23 cities, primarily in the Pearl River Delta and the Yangtze River Delta, the major developed industrial areas. We now have approval for 10 more cities in 2005.

I've seen incredible changes in the infrastructure since I started going to China in the early 1990's. Transformation takes place very quickly. I find it amazing how fast and efficiently it happens. Take Shenzhen, across from Hong Kong. In 1998 it was mostly farmland. Today, there are 22 million people and it looks like New York City.

The speed at which things get done in China is phenomenal. There's an island outside Shanghai-the Yangshan Deep Port-that's going to be one of their main ocean ports and they constructed a 30-kilometer bridge out to it. The bridge will be built in about a year! Thirty kilometers! Imagine how long that would take in the U.S.

Their highways are a lot like in the U.S., the network is similar to the Eisenhower interstate network built in the 1950s.

The key to our networks in China will be warehouses. We want to be the first in all the major cities. Our strategy is to provide full service to retailers-big and small. For example, we will receive and consolidate goods from their in-country vendors and then do a DC by-pass directly to their customers. We're making the big warehouse investments now while the cost of entry is not exorbitant. But prices go up quickly and you've got to stay ahead of the curve. We had a facility in south China, which took four months to build and when we closed it was worth close to $3 million more than when we started-an appreciation of 20 percent in four months.

We have nearly 400,000 square feet of warehouse in Yantian, a key port in south China, and 2 million throughout the country (in the U.S. we have 35 million square feet).

There doesn't seem to be a problem with capacity except perhaps with air in Hong Kong and Shanghai during peak season. If the West Coast of the U.S. blocks up, a lot of freight will convert from ocean to air and then there will be capacity problems in all of China.

John Hafferty is the UPS Supply Chain Solutions vice president for Europe and Asia.