The manufacturing numbers tell the story of why China’s economy is undergoing a fundamental restructuring. Average wages increased more than 130 percent in the seven years to 2006 and by almost 20 percent a year from 2005 to 2010. In the Yangtze River Delta, labor costs are expected to jump 20 percent a year over the next four years, and electricity tariffs have increased 15 percent since 2010. Industrial land prices have soared to $11 to $21 per square foot in many coastal cities, 10 times as expensive as some southern U.S. states.
“Coastal China is a victim of its own success,” said Rajiv Biswas, Asia-Pacific chief economist at IHS Global Insight. “Wage costs on the coast have risen to middle income levels. This is affecting the ability of companies there to compete. We have seen this before in Japan, South Korea and Taiwan; as the cost of labor goes up, low-cost manufacturing moves.”
Rising costs have pushed some companies to countries such as Cambodia and Vietnam where inputs are lower. Others have “in-sourced” production to consumer markets such as Europe and the U.S., where higher production costs can be offset by reduced supply chain expenses and risk exposure.
But most companies are opting simply to relocate within China in search of more competitive production sites, a trend analysts expect to continue.
For companies shipping primarily to export markets by air, or those whose main target is the ravenous domestic market, the payoff can be spectacular, not least because the government’s “Go West” policy of building infrastructure and providing tax incentives also offers a number of draws.
“Over the next 10 years, we’ll see this continue in coastal China,” Biswas said. “A lot will go inland where wages are lower. Many companies no longer need to be on the coast because China’s domestic market is increasingly important for sectors such as auto, which are no longer set up for exports.”
This huge industrial shift in production, of course, has a profound effect on planning by manufacturers and the third-party logistics providers that serve their supply chain needs. DHL and others are scrambling to reorient their China networks as original equipment manufacturers migrate from China’s traditional factory belts on the eastern and southern coasts.
For DHL, the shift was most pronounced in the high-tech sector where companies were rapidly transferring production capacity away from the most developed Tier 1 cities such as Beijing and Shenzhen into Tier 1.5 transitional interior cities such as the growing international hubs of Chengdu and Chongqing, said Yin Zou, senior director of strategy at DHL Supply Chain. Some have taken a bigger leap of faith, establishing operations in emerging centers such as Zhengzhou and Taiyuan.
“We’re looking at how to transform our distribution centers in the east to this trend, and how to ramp up our facilities and footprint in the middle and west part of China,” Zou said.
Panalpina also is building up its overland distribution capabilities to support customers’ raw materials and finished goods movements. As supply chains lengthen, companies are placing more emphasis on Tier 1.5 cities and below to boost coverage of the domestic market. Panalpina, for example, last fall opened its 10,000-square-meter Tianjin Logistics Center, “to support one of our global customers,” said Linus Wong, Panalpina’s area head of logistics for Greater China. “We will continue to stay close to the customers, wherever they go.”
Hong Kong-based Kerry Logistics has been building facilities in interior cities since 2008 as customer requirements have evolved because of rising coastal costs. “There is growing demand in central and western regions of China, particularly in the large municipalities,” a spokesman said. “As a consequence, there is increased demand for trucking from the ports to inland regions.”
Gary Chan, managing director for North Asia at Philadelphia-based BDP International, said the shift of production gathered speed after the 2009 financial crisis as China moved to reduce its dependence on international trade and began to develop its Tier 2 and Tier 3 cities away from the southern coast.
Although provincial governments in places such as Chongqing and Chengdu are providing incentives, however, a lack of infrastructure and integrated multimodal transport is impeding progress, he said. “Inland distribution costs are expensive, so for companies mainly in the domestic market, then they go inland,” Chan said. “If it is exports, then they mostly stay on the coast, but perhaps shift north to places such as Dalian and Tianjin, which were previously known for heavy goods but which are now doing white goods and have the ports and infrastructure.
“For companies inland, it’s not just about getting one truck and driving to the coast. Different provinces and cities require different licenses, or you need a local driver or truck, so it’s not easy,” he added. “From Chongqing, you might use a barge, but there can be delays on delivery due to heavy traffic. The government has to come in to help, to enable better truck and rail services and integrated transport.”
Another issue away from the coast is the availability of warehousing and other facilities suitable for developing as full-blown distribution centers. Rents in coastal cities are on average some 30 percent higher than in Tier 1.5 cities, Wong said, and the differential could be even more severe in lower-tier cities.
Modern warehouse rental rates away from the coast offer big savings, with typical rents of 18 to 20 cents per square meter per day applying in Tier 1 cities, falling to around 13 cents in cities such as Wuhan and Chengdu, Zou said. But, he added, although Chengdu has a logistics park at the airport, Chongqing “had not planned for logistics, just factories” and Wuhan has taken a “fragmented” approach rather than adopting a campus-style strategy for logistics development.
Indeed, China’s logistics strategy in economic development not only is uncoordinated, but the lack of planning also is creating shortages of quality warehousing suitable for development as distribution centers. One reason for this is that provincial governments in the north and interior have focused on attracting high-employing, high-tax-paying industries, but unlike their counterparts on the coast, don’t have the appreciation — at least not yet — that modern manufacturing and retailing is impossible without a well-developed logistics infrastructure.
“Logistics companies are certainly not in the top list of tax- and employment-generating sectors,” Wong said. “Unless the land is solely for logistics use, the local authorities would prefer to attract companies that could help generate more tax and employment opportunities.”
High land prices in many cities also push out logistics providers, while the highly regulated nature of the sector, and the many regulatory barriers and controls at national, provincial and city levels, are thwarting the development of efficient distribution networks.
A recent study by Jones Lang LaSalle called “China 50: Fifty Real Estate Markets That Matter” concluded China’s logistics industry is “severely undersupplied with quality space.” Local developers dominated the supply of logistics facilities across the 50 cities the study analyzed, with the entire sector at an early stage of evolution.
“The existing international grade logistics stock — including Tier 1 cities Beijing, Shanghai, Guangzhou and Shenzhen — totals only 140 million square feet, barely equivalent to the warehousing stock of Boston,” the report said. It said 60 percent of this stock is in Tier 1 cities, with much of that in the Yangtze River Delta area around Shanghai and Suzhou.
The outlook for new facility construction inland and north isn’t particularly bright. “By the middle of the decade, China’s total international grade stock is expected to have risen to 215 million square feet, but most of this growth will be in the existing primary logistics hubs,” the Jones Lang LaSalle study said.
The upshot of these supply chain barriers in existing areas is that most international 3PLs are largely still operating from DCs on the coast, Chan said, with some now establishing satellite regional DCs inland. “These are not the most advanced facilities in general, and are largely geared at shipping and reworking products produced on the coast and sold into the domestic market,” he said. “Most of the incentives for inland investments are for production and call centers typically with three- to five-year tax breaks. Governments are not looking at attracting logistics facilities.
“They should be looking to attract foreign logistics companies, but they don’t and we need special licenses,” Chan said. “This is a continental market, but most of the DCs are still only on the coast.”
Notwithstanding capacity issues, new demand for complex supply chain solutions covering the export trades and domestic distribution offers huge potential for transport providers already achieving their highest growth rates from northern and interior China.
“As industry migrates inland, demand for logistics services will increase both for domestic and international shipments,” said John Lu, chairman of the Asian Shippers’ Council. “With longer supply chains to reach international markets, this is a tremendous opportunity for those who can supply sophisticated logistics services that will help China integrate its infrastructure and bring the cost of manufacturing down.”
Contact Mike King at firstname.lastname@example.org.