China Foto Press

Focus: Supply Chain

China Supply Chain Development

China's supply chain landscape is changing dramatically, and companies should note developments in inventory, logistics, and capacity management

by Bradley A. Feuling

More than 30 years ago, production in China served only one customer, the PRC government. Prices were fixed, national planners placed sales orders directly, and state-owned enterprises coordinated local logistics. The China supply chain was forever altered in 1978, however, when it was exposed to new international complexities. Global customers and suppliers, along with competitive forces, ushered in a new phase in China's supply chain development. The creation of China's first special economic zone—in Shenzhen, Guangdong—was the first major step in the development of China's export-oriented economy and the supply chain necessary to serve that economy. China's new international links multiplied as its domestic market expanded, and now China is part of more than half of the world's supply chains.

Quick Glance

To avoid delays and high costs, companies must consider new developments in inventory, logistics, and capacity management.
Managing the four types of inventory—raw material, work-in-process, finished goods, and goods in transit—is critical to a supply chain's efficiency in China.
Improving capacity management and achieving demand-product synchronization can cut costs and improve efficiency.

Until recently, Chinese manufacturing was seen as advantageous merely in low-cost production. Many Chinese industries are now maturing through the supply chain development cycle, in which companies focus first on cost then quality, operational efficiency, and knowledge. Managers responsible for monitoring supply chain costs and service levels create substantial risks by neglecting the role of upstream Chinese processes, which include raw material order scheduling, raw material and work-in-process inventory management, and logistics in China. (Downstream processes include transoceanic logistics, destination country distribution, and finished goods inventory management.)

Current trends in China supply chain development

China's supply chain landscape has changed drastically in the last 10 years. Investments in distribution networks, logistics, and infrastructure have helped improve operations. For example, the phased development of Yangshan Deepwater Port, located near Shanghai, expanded throughput capacity by 5.2 million 20-foot equivalent units (TEUs) between 2002 and 2006. China's 11th Five-Year Plan (2006-10) also includes an annual $8 billion investment in railways, which currently carry 30 percent of China's goods traffic. (China's cargo transport rose 85 percent year on year in 2008.) Major infrastructure investment promises to add more than 13,000 miles of rail per year between 2006 and 2020 and 97 new airports by 2020.

Yet for manufacturers in China, rising costs and appreciation against foreign currencies are reducing once sizeable profit margins (see Box). On the one hand, companies are closing because of unprofitable operations. In a recent survey by the Chinese Cotton Textile Association, 49.2 percent of companies suggest that they were interested in leaving the industry. On the other hand, PRC government policies are attracting foreign investment to inner provinces.

With a maturing business climate, companies face greater opportunities and risks. These are compounded by longer supply chains, in which manufacturing and raw material sourcing increasingly take place in central and western China. Existing inefficiencies in material, information, and financial flows create delays and raise costs. To avoid delays, companies should consider upstream factors, especially inventory, logistics, and capacity management.

Finished goods inventory

It is important for companies to have a finished goods inventory large enough to satisfy demand. But according to last October's IBM Global Business Services 2007 Mainland China Value Chain Study, roughly 66 percent of Chinese operations experience cash-to-cash cycle times (the time between cash outflow for product or material payment to cash inflow from customer payment) of longer than 30 days, compared to 60 percent in Europe and 59 percent in North America. Companies, specifically manufacturers, require cash for investment in inventory and capacity expansion. With 6 percent fewer companies receiving cash within 30 days, Chinese manufacturers are prone to higher lead-time delay risks because they do not have enough cash to maintain sufficient inventory. If delivery dates are fixed, production will be hurried, increasing the risk of quality loss and the need for costly express deliveries.

Capacity

Many industry professionals indicate that certain sectors, such as automotive, textile, and equipment manufacturing, suffer from overcapacity. Some large facilities are producing far less than their potential output, especially in the pharmaceutical and furniture industries. In other industries, such as engine manufacturing or cement production, supply cannot satisfy global demand, and strong suppliers to foreign customers have reached full capacity because of their highly valued capabilities, including high-quality production, strong customer service, and the ability to expand while offering higher value-added services, such as involvement in design and product-line expansion. Other local manufacturers are using initial public offerings to generate capital for expansionary investment.

A closer inspection of the logistics industry reveals high fragmentation and underdeveloped use of logistics capacity. The lack of nationwide connectivity in transportation significantly affects material movement flows, costs, and throughput capacity. When a truck reaches provincial borders, it must often unload and reload its cargo into a new truck with the appropriate provincial license plates. Burdensome requirements such as these affect material handling costs and may lead to product damage. China: Logistics and Distribution Industry, released by the JLJ Group in March 2007, estimates total company spending on logistics—including rail, road, inland water, air, and warehousing storage—in China at nearly $490 billion, accounting for 20 percent of China's gross domestic product (GDP). In the United States, in contrast, logistics spending makes up only 9 percent of GDP.

New technologies

New technologies, such as enterprise resource planning and electronic data interchange, simplify intercompany procedures and centralize information flows, reducing processing time and providing more data and visibility to supply chain contributors. Overall acceptance of new technologies, however, remains quite low. IBM estimates that 12 percent of local Chinese companies electronically share demand and inventory data in real time with supply chain partners. Investment in such software has come primarily from advanced foreign operations in China. Many Chinese companies still track processes such as raw material order placement and inbound and outbound scheduling by hand or transfer data over the phone, which means that they cannot use the data for analytical purposes. This creates significant hurdles when considering process or continuous improvement programs that require data for trend analysis, benchmarking, and goal targeting.

Talent

By 2010, China's logistics industry will need 400,000 professionals, yet PRC universities graduate only about 10,000 students per year from logistics-related programs, according to Logistics Management. Many of these degrees were first given just five years ago. Supply chain management study programs are even rarer. (Logistics studies focus on physical material flow processes and information flows that affect procedures such as transportation routing, scheduling, and material handling, including packaging. Supply chain studies focus on physical material flow process design and the organization of material, information, and financial flows. It also manages demand and procurement planning, capacity, and inventory throughout the entire supply chain.) In most cases, companies will have to share their own knowledge to educate their staff and partners.

New developments

The next phase of China's supply chain development will focus on improving productivity and efficiency, especially in inventory, logistics, and capacity management. Companies will also take steps to better synchronize demand and production.

Inventory management in China

Inventory management includes all four types of inventory: raw material, work-in-process, finished goods, and goods in transit. In China, most local manufacturers do not differentiate the types of inventory, though costs for each can vary greatly. For example, holding costs for raw material and finished goods inventories differ, and retail storage space is often more expensive than warehousing space. Managers of work-in-process inventory must consider production scheduling, which is rarely in sync with end-customer demand.

Routine stock shortages and delays in raw material management are raising manufacturing costs. Local companies face challenges in supplier selection, inventory accuracy, and reorder point policies (the level at which inventory must be replenished is required). Instead of anticipating demand, many companies fulfill incoming demand reactively, which can create longer-term problems. In addition, upstream suppliers subject to demand and cost pressures may be tempted to substitute inferior input materials. Linking point-of-sale data with manufacturing production schedules would improve information flows and reduce these types of incidents.

Work-in-process models, such as production or warehouse layout, are commonly left to manufacturers or local third-party logistics providers, and few local companies implement continuous improvement. Assembly line configurations, for example, are often designed without quantitative analytics that consider functionality and time optimization for material flow processes. As a result, station, inventory, and material handling locations are assigned randomly. Manufacturers without access to time and throughput data frequently face higher production costs and reduced capacity utilization. Improvements in this area will be vital to improving supply chain efficiency.

Another important factor is the management of finished-goods inventory. According to IBM, 97 percent of Chinese manufacturers had finished-goods inventory turnover of four turns or higher, meaning that they replaced their entire inventory at least four times each year. (China averages 27 turns per year, while the global average is 23 turns.) Most of the companies IBM surveyed are export-oriented, and their finished-goods inventories are generally low because their products are shipped overseas almost immediately. With considerations such as production and delivery lead times, keeping low finished-goods inventories may be justified to maintain a higher service level. Having higher inventory levels close to the customer (in the export destination) can minimize stockout risks at the point of sale. Nevertheless, an improper balance of inventory among the manufacturer in China, in transit, and in the customer's distribution location can create inefficiencies, as the cost of holding inventory varies at different points in the supply chain.

In-transit inventory is another commonly overlooked area. For instance, a product purchasing department may order products without realizing that a new shipment was already delivered, creating excess inventory and increasing holding costs. Because of a lack of training and education in supply chain operations, PRC manufacturers in the middle of the supply chain have difficulty coping with unsynchronized fluctuations from customers and suppliers, which can result in excess inventory or high rates of stock-out.

Logistics, capacity, and demand-production synchronization

Logistics management is highly fragmented in China, and consolidation can improve operations, reduce costs, and even address environmental concerns. Without the efficiencies of consolidation, less-than-truckload shipping becomes more common, affecting product quality during transportation. Limited integration between capacity management and order tracking limits the flexibility of localized trucking. For example, once shippers have delivered a load to a retailer, trucks are often empty on the return trip. Long-haul freight is influenced by current regulations that cause delay and raise costs. For instance, some drivers avoid toll roads to cut expenses. The trade-off is that non-toll roads are often poorly maintained and indirectly routed, lengthening transportation time and increasing indirect costs and the likelihood of delays.

Greater efficiency in logistics not only cuts costs but improves corporate social responsibility. Using less packaging and running trucks only when full reduces truck use and related costs and emissions. Similarly, moving only full containers increases the efficiency of transoceanic shipping, further lowering emissions. In the rush to fill export demand, many companies in China rarely consider these factors. Coordinating third-party logistics management between the manufacturer and customer often leads to better results. As coordinated supply chains become more common, however, upstream operations are changing.

Capacity management provides another opportunity to improve efficiency. Accurately understanding the capacity of suppliers all along the supply chain is important when integrating supply chain operations. This takes a detailed knowledge of throughput levels, yet many facilities do not engage in operational or process mapping, which lead to a clearer understanding of where bottlenecks occur and how to prevent them. It is important to have sufficient inventory and logistics capacity, but over-investment in capacity may hinder productivity. For example, investment in additional warehousing can lead to higher holding costs.

A last consideration is improving demand-production synchronization. For a manufacturer to accurately maintain inventory and prepare a production schedule, process flow and collaboration between the manufacturer and customer is critical. In most cases, companies adjust demand forecasts or place orders without taking lead times into account. As a result, costs increase, quality is more variable, and product shipments are more frequently delayed. Supply chain design and process flow charting can track material, information, and financial flows and procedures throughout the supply chain. Integration and coordination are integral to building sustainable supply chain advantages.

Transition on the horizon

As participants in China's supply chain seek to satisfy local and foreign demand, some are turning to alternative sourcing locations, such as Vietnam. To strengthen competitive advantages in China, businesses must work with upstream supply chain participants to enhance productivity and efficiency.

Global supply chains rely on a combination of local and foreign knowledge. Coordination in material, information, and financial flows all along the supply chain will be critical to further integrating local and global supply chains.

Rising Costs Squeeze Profit Margins for PRC Manufacturers

Costs are rising across the board in China, driven by higher labor, manufacturing overhead, and raw material input prices and currency movements.

Labor costs Hewitt Associates reported that in 2006 average salary rates increased 7-9 percent in first-tier cities such as Beijing and 7.5-10.6 percent in second-tier cities such as Hangzhou, Zhejiang. In a recent HSBC study, average annual manufacturing salaries had more than doubled between 2000 and 2006.
Facility investment and machinery As China develops, previously desirable business locations, such as Shanghai and Shenzhen, Guangdong, are becoming more expensive, but Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion.Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion.Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion.Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion. are not unique to large cities. Companies are seeking lower-cost locations as real estate prices climb steeply—by an average of more than 11 percent year on year in 70 cities in the first quarter of 2008.
Raw material prices are also driving up production equipment prices, affecting both local and foreign operations. Global demand is driving prices higher for everything from wood to steel. According to the PRC National Bureau of Statistics, the purchaser prices for raw material, fuel, and power rose by 11.1 percent in the first half of 2008. With rising prices in China and slowing demand in major export markets, many manufacturers are facing shrinking profit margins.
The RMB From July 2007 to July 2008, China's currency, the renminbi, appreciated 10 percent against the US dollar. For PRC-based exporters, this has led to an immediate profit loss and higher risks for long-term planning. Notably, currency appreciation has also boosted exports from the United States to China (see US Exports to China Hit New High). The tides of global trade are only starting to shift.

—Bradley Feuling

Top Supply Chain Issues in China

With the rise of China as a major global supplier in the last decade, global sourcing giants and smaller companies alike are dealing with a rapidly developing supply chain. Despite the recent improvements in China's supply chain, many participants still need to adopt international best practices to improve efficiency and provide a consistent level of service. Companies operating in China must also learn to cope with rapidly changing government policy and economic fluctuations, which in the last year or so have driven costs up in some parts of the supply chain. In this time of rising costs and focus on the environment, efficiency is the key to competitiveness at the company level.

Information

The top supply chain issue in China is information sharing. Ideally, supply and demand are linked through the sharing of information and data, but in China, the industry's sharing of information is still far from optimal. To improve business processes and make further efficiency gains, information must be shared more promptly along the supply chain. This idea is new to many businesses in China's supply chain, however, and many manufacturers still maintain an in-house logistics division instead of outsourcing logistics and focusing on their core business.

As awareness of the benefits of outsourcing grows, more companies are realizing that they can outsource the logistics function and are hiring third-party organizations to streamline their logistics and distribution processes, as well as to assist with information sharing and data management systems. In the next five years, many Chinese manufacturers will improve efficiency by outsourcing non-core functions, and the biggest efficiency gains will likely stem from the outsourcing of logistics and information technology functions.

Balance of supply and demand

Second, the balance (or imbalance) of supply and demand affects global supply chain efficiency. New business ventures have been flooding into emerging markets like China and India in waves. These fluctuating waves of investment—and the demand they create—have disrupted supply chains, resulting in the unpredictable supply of some products and the rise of a wide range of logistics services that vary in quality. To reduce uncertainties, the industry needs to adopt international best practices in supply chain management, such as ISO 28000:2007, a recent international standard for supply chain security management systems. Such standards will help emerging markets like China keep their competitive edge.

PRC policy

In China, policies change rapidly and often without adequate time to prepare for implementation. Last year's value-added tax (VAT) rebate cuts—designed to discourage low-end, polluting products—and other new rules are now squeezing low-end manufacturers and spurring changes in the supply chain. For example, some chopsticks for the Japanese market, previously made in China, are now made in Russia because of regulations aimed at halting deforestation in China. From Russia, the chopsticks will be exported to Dalian, Liaoning, where they will be enhanced with small value-added services in bonded zones. This process is called "simple circulation processing" and is relatively new to the market. After that, the chopsticks will go directly to Japanese supermarkets. In late July 2008, some of the export VAT rebate cuts were reversed—another example of China's constantly changing policies.

Current government policy encourages the creation and manufacture of innovative, high-value products. China is also creating stronger incentives for companies to move inland in an effort to reduce the disparity between coastal and inland areas and to create new, innovative organizations in research and development as well as in the information technology sector.

Jurgen Reinderink is secretary and treasurer, the Council of Supply Chain Management Professionals China, and marketing director, EH SCM Group. He is currently based in Hong Kong.

Rich Products Corporation

Kevin Malchoff is president, International Business Group, Rich Products Corp. CBR Assistant Editor Dan Strouhal recently interviewed Malchoff about Rich Products' cold-chain logistics operations in China.

CBR: What unique conditions does Rich Products face as a provider of cold foods storage and transport in China?

Malchoff: As we began to expand our presence in China in 1998, we faced a number of challenges. The country's road and rail infrastructure was just beginning to develop, and it is still developing today. We also found it difficult to find a logistics business with enough cold-enabled trucks to support our growing business. Finally, we needed a warehouse network to ensure our products would be stored and handled safely, while maintaining superior quality.

CBR: How has Rich Products adapted to these conditions? What does the company do differently in China?

Malchoff: The challenges I just mentioned, and our desire to rapidly grow our food business in China, drove us to acquire a majority interest in Kangxin Logistics (Tianjin) Ltd. Co. (KX Logistics), a cold-chain third-party logistics company based in China, in 2003. In forming our joint venture relationship with KX Logistics, we received the benefit of a partner who had been in the business for years and a leader, Wei Gao (current KX Logistics general manager), who was passionate about the cold-chain logistics business and had already developed a solid customer base. We also gained access to a state-of-the art fleet of cold-enabled trucks that keep our products at the correct temperatures; trained drivers to deliver our products to our customers on time and in great condition; and a network of refrigerated and frozen warehouses in strategic locations throughout China.

Since then, we have enjoyed a successful partnership, which has resulted in significant growth. Today, KX Logistics is the leading cold-chain third-party logistics company in China. We have a multinational customer base, more than 350 associates and warehouses, and offices across China.

CBR: Rich Products' operations cover more than 300 cities nationwide. How has the company overcome the variations in geography and infrastructure differences from province to province?

Malchoff: In each province, we have team members who are residents of the local cities and who understand the local customs, as well as the unique needs of our local customers. We also learned early on that most laws in China are not created at the national level. Instead, each province is responsible for the creation and enforcement of its own laws and regulations. Therefore, it is critical that our people in each province understand the local laws and regulations and ensure we remain in compliance.

CBR: In May 2008, Rich Products and KX Logistics opened a state-of-the-art refrigeration warehouse in Beijing. Has the warehouse experienced any difficulty since opening?

Malchoff: We have not experienced any significant problems to date. I attribute our success in this regard to our experienced operations and engineering staff that has learned a great deal from building and opening warehouses in other cities across China and in other markets. We have also developed a first-class associate training program, which ensures we have the proper focus on product and worker safety on a day-to-day basis.

CBR: How will China's cold-chain logistics change in the next 5 to 10 years?

Malchoff: Demand for frozen food products will continue to grow, driven by an increasing focus on food safety and an emerging middle class with more discretionary income to spend on convenience items. Likewise, the cold-chain logistics network will need to expand to meet the growing demand for frozen food products, which bodes well for KX Logistics. We believe that the services KX Logistics provides will allow multinational manufacturers of frozen and refrigerated foods to grow at an accelerated rate in China.

Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion.

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	China Foto Press Print Article Focus: Supply Chain China Supply Chain Development China's supply chain landscape is changing dramatically, and companies should note developments in inventory, logistics, and capacity management by Bradley A. Feuling More than 30 years ago, production in China served only one customer, the PRC government. Prices were fixed, national planners placed sales orders directly, and state-owned enterprises coordinated local logistics. The China supply chain was forever altered in 1978, however, when it was exposed to new international complexities. Global customers and suppliers, along with competitive forces, ushered in a new phase in China's supply chain development. The creation of China's first special economic zone—in Shenzhen, Guangdong—was the first major step in the development of China's export-oriented economy and the supply chain necessary to serve that economy. China's new international links multiplied as its domestic market expanded, and now China is part of more than half of the world's supply chains. Quick Glance To avoid delays and high costs, companies must consider new developments in inventory, logistics, and capacity management. Managing the four types of inventory—raw material, work-in-process, finished goods, and goods in transit—is critical to a supply chain's efficiency in China. Improving capacity management and achieving demand-product synchronization can cut costs and improve efficiency. Until recently, Chinese manufacturing was seen as advantageous merely in low-cost production. Many Chinese industries are now maturing through the supply chain development cycle, in which companies focus first on cost then quality, operational efficiency, and knowledge. Managers responsible for monitoring supply chain costs and service levels create substantial risks by neglecting the role of upstream Chinese processes, which include raw material order scheduling, raw material and work-in-process inventory management, and logistics in China. (Downstream processes include transoceanic logistics, destination country distribution, and finished goods inventory management.) Current trends in China supply chain development China's supply chain landscape has changed drastically in the last 10 years. Investments in distribution networks, logistics, and infrastructure have helped improve operations. For example, the phased development of Yangshan Deepwater Port, located near Shanghai, expanded throughput capacity by 5.2 million 20-foot equivalent units (TEUs) between 2002 and 2006. China's 11th Five-Year Plan (2006-10) also includes an annual $8 billion investment in railways, which currently carry 30 percent of China's goods traffic. (China's cargo transport rose 85 percent year on year in 2008.) Major infrastructure investment promises to add more than 13,000 miles of rail per year between 2006 and 2020 and 97 new airports by 2020. Yet for manufacturers in China, rising costs and appreciation against foreign currencies are reducing once sizeable profit margins (see Box). On the one hand, companies are closing because of unprofitable operations. In a recent survey by the Chinese Cotton Textile Association, 49.2 percent of companies suggest that they were interested in leaving the industry. On the other hand, PRC government policies are attracting foreign investment to inner provinces. With a maturing business climate, companies face greater opportunities and risks. These are compounded by longer supply chains, in which manufacturing and raw material sourcing increasingly take place in central and western China. Existing inefficiencies in material, information, and financial flows create delays and raise costs. To avoid delays, companies should consider upstream factors, especially inventory, logistics, and capacity management. Finished goods inventory It is important for companies to have a finished goods inventory large enough to satisfy demand. But according to last October's IBM Global Business Services 2007 Mainland China Value Chain Study, roughly 66 percent of Chinese operations experience cash-to-cash cycle times (the time between cash outflow for product or material payment to cash inflow from customer payment) of longer than 30 days, compared to 60 percent in Europe and 59 percent in North America. Companies, specifically manufacturers, require cash for investment in inventory and capacity expansion. With 6 percent fewer companies receiving cash within 30 days, Chinese manufacturers are prone to higher lead-time delay risks because they do not have enough cash to maintain sufficient inventory. If delivery dates are fixed, production will be hurried, increasing the risk of quality loss and the need for costly express deliveries. Capacity Many industry professionals indicate that certain sectors, such as automotive, textile, and equipment manufacturing, suffer from overcapacity. Some large facilities are producing far less than their potential output, especially in the pharmaceutical and furniture industries. In other industries, such as engine manufacturing or cement production, supply cannot satisfy global demand, and strong suppliers to foreign customers have reached full capacity because of their highly valued capabilities, including high-quality production, strong customer service, and the ability to expand while offering higher value-added services, such as involvement in design and product-line expansion. Other local manufacturers are using initial public offerings to generate capital for expansionary investment. A closer inspection of the logistics industry reveals high fragmentation and underdeveloped use of logistics capacity. The lack of nationwide connectivity in transportation significantly affects material movement flows, costs, and throughput capacity. When a truck reaches provincial borders, it must often unload and reload its cargo into a new truck with the appropriate provincial license plates. Burdensome requirements such as these affect material handling costs and may lead to product damage. China: Logistics and Distribution Industry, released by the JLJ Group in March 2007, estimates total company spending on logistics—including rail, road, inland water, air, and warehousing storage—in China at nearly $490 billion, accounting for 20 percent of China's gross domestic product (GDP). In the United States, in contrast, logistics spending makes up only 9 percent of GDP. New technologies New technologies, such as enterprise resource planning and electronic data interchange, simplify intercompany procedures and centralize information flows, reducing processing time and providing more data and visibility to supply chain contributors. Overall acceptance of new technologies, however, remains quite low. IBM estimates that 12 percent of local Chinese companies electronically share demand and inventory data in real time with supply chain partners. Investment in such software has come primarily from advanced foreign operations in China. Many Chinese companies still track processes such as raw material order placement and inbound and outbound scheduling by hand or transfer data over the phone, which means that they cannot use the data for analytical purposes. This creates significant hurdles when considering process or continuous improvement programs that require data for trend analysis, benchmarking, and goal targeting. Talent By 2010, China's logistics industry will need 400,000 professionals, yet PRC universities graduate only about 10,000 students per year from logistics-related programs, according to Logistics Management. Many of these degrees were first given just five years ago. Supply chain management study programs are even rarer. (Logistics studies focus on physical material flow processes and information flows that affect procedures such as transportation routing, scheduling, and material handling, including packaging. Supply chain studies focus on physical material flow process design and the organization of material, information, and financial flows. It also manages demand and procurement planning, capacity, and inventory throughout the entire supply chain.) In most cases, companies will have to share their own knowledge to educate their staff and partners. New developments The next phase of China's supply chain development will focus on improving productivity and efficiency, especially in inventory, logistics, and capacity management. Companies will also take steps to better synchronize demand and production. Inventory management in China Inventory management includes all four types of inventory: raw material, work-in-process, finished goods, and goods in transit. In China, most local manufacturers do not differentiate the types of inventory, though costs for each can vary greatly. For example, holding costs for raw material and finished goods inventories differ, and retail storage space is often more expensive than warehousing space. Managers of work-in-process inventory must consider production scheduling, which is rarely in sync with end-customer demand. Routine stock shortages and delays in raw material management are raising manufacturing costs. Local companies face challenges in supplier selection, inventory accuracy, and reorder point policies (the level at which inventory must be replenished is required). Instead of anticipating demand, many companies fulfill incoming demand reactively, which can create longer-term problems. In addition, upstream suppliers subject to demand and cost pressures may be tempted to substitute inferior input materials. Linking point-of-sale data with manufacturing production schedules would improve information flows and reduce these types of incidents. Work-in-process models, such as production or warehouse layout, are commonly left to manufacturers or local third-party logistics providers, and few local companies implement continuous improvement. Assembly line configurations, for example, are often designed without quantitative analytics that consider functionality and time optimization for material flow processes. As a result, station, inventory, and material handling locations are assigned randomly. Manufacturers without access to time and throughput data frequently face higher production costs and reduced capacity utilization. Improvements in this area will be vital to improving supply chain efficiency. Another important factor is the management of finished-goods inventory. According to IBM, 97 percent of Chinese manufacturers had finished-goods inventory turnover of four turns or higher, meaning that they replaced their entire inventory at least four times each year. (China averages 27 turns per year, while the global average is 23 turns.) Most of the companies IBM surveyed are export-oriented, and their finished-goods inventories are generally low because their products are shipped overseas almost immediately. With considerations such as production and delivery lead times, keeping low finished-goods inventories may be justified to maintain a higher service level. Having higher inventory levels close to the customer (in the export destination) can minimize stockout risks at the point of sale. Nevertheless, an improper balance of inventory among the manufacturer in China, in transit, and in the customer's distribution location can create inefficiencies, as the cost of holding inventory varies at different points in the supply chain. In-transit inventory is another commonly overlooked area. For instance, a product purchasing department may order products without realizing that a new shipment was already delivered, creating excess inventory and increasing holding costs. Because of a lack of training and education in supply chain operations, PRC manufacturers in the middle of the supply chain have difficulty coping with unsynchronized fluctuations from customers and suppliers, which can result in excess inventory or high rates of stock-out. Logistics, capacity, and demand-production synchronization Logistics management is highly fragmented in China, and consolidation can improve operations, reduce costs, and even address environmental concerns. Without the efficiencies of consolidation, less-than-truckload shipping becomes more common, affecting product quality during transportation. Limited integration between capacity management and order tracking limits the flexibility of localized trucking. For example, once shippers have delivered a load to a retailer, trucks are often empty on the return trip. Long-haul freight is influenced by current regulations that cause delay and raise costs. For instance, some drivers avoid toll roads to cut expenses. The trade-off is that non-toll roads are often poorly maintained and indirectly routed, lengthening transportation time and increasing indirect costs and the likelihood of delays. Greater efficiency in logistics not only cuts costs but improves corporate social responsibility. Using less packaging and running trucks only when full reduces truck use and related costs and emissions. Similarly, moving only full containers increases the efficiency of transoceanic shipping, further lowering emissions. In the rush to fill export demand, many companies in China rarely consider these factors. Coordinating third-party logistics management between the manufacturer and customer often leads to better results. As coordinated supply chains become more common, however, upstream operations are changing. Capacity management provides another opportunity to improve efficiency. Accurately understanding the capacity of suppliers all along the supply chain is important when integrating supply chain operations. This takes a detailed knowledge of throughput levels, yet many facilities do not engage in operational or process mapping, which lead to a clearer understanding of where bottlenecks occur and how to prevent them. It is important to have sufficient inventory and logistics capacity, but over-investment in capacity may hinder productivity. For example, investment in additional warehousing can lead to higher holding costs. A last consideration is improving demand-production synchronization. For a manufacturer to accurately maintain inventory and prepare a production schedule, process flow and collaboration between the manufacturer and customer is critical. In most cases, companies adjust demand forecasts or place orders without taking lead times into account. As a result, costs increase, quality is more variable, and product shipments are more frequently delayed. Supply chain design and process flow charting can track material, information, and financial flows and procedures throughout the supply chain. Integration and coordination are integral to building sustainable supply chain advantages. Transition on the horizon As participants in China's supply chain seek to satisfy local and foreign demand, some are turning to alternative sourcing locations, such as Vietnam. To strengthen competitive advantages in China, businesses must work with upstream supply chain participants to enhance productivity and efficiency. Global supply chains rely on a combination of local and foreign knowledge. Coordination in material, information, and financial flows all along the supply chain will be critical to further integrating local and global supply chains. Rising Costs Squeeze Profit Margins for PRC Manufacturers Costs are rising across the board in China, driven by higher labor, manufacturing overhead, and raw material input prices and currency movements. Labor costs Hewitt Associates reported that in 2006 average salary rates increased 7-9 percent in first-tier cities such as Beijing and 7.5-10.6 percent in second-tier cities such as Hangzhou, Zhejiang. In a recent HSBC study, average annual manufacturing salaries had more than doubled between 2000 and 2006. Facility investment and machinery As China develops, previously desirable business locations, such as Shanghai and Shenzhen, Guangdong, are becoming more expensive, but Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion.Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion.Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion.Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion. are not unique to large cities. Companies are seeking lower-cost locations as real estate prices climb steeply—by an average of more than 11 percent year on year in 70 cities in the first quarter of 2008. Raw material prices are also driving up production equipment prices, affecting both local and foreign operations. Global demand is driving prices higher for everything from wood to steel. According to the PRC National Bureau of Statistics, the purchaser prices for raw material, fuel, and power rose by 11.1 percent in the first half of 2008. With rising prices in China and slowing demand in major export markets, many manufacturers are facing shrinking profit margins. The RMB From July 2007 to July 2008, China's currency, the renminbi, appreciated 10 percent against the US dollar. For PRC-based exporters, this has led to an immediate profit loss and higher risks for long-term planning. Notably, currency appreciation has also boosted exports from the United States to China (see US Exports to China Hit New High). The tides of global trade are only starting to shift. —Bradley Feuling Top Supply Chain Issues in China With the rise of China as a major global supplier in the last decade, global sourcing giants and smaller companies alike are dealing with a rapidly developing supply chain. Despite the recent improvements in China's supply chain, many participants still need to adopt international best practices to improve efficiency and provide a consistent level of service. Companies operating in China must also learn to cope with rapidly changing government policy and economic fluctuations, which in the last year or so have driven costs up in some parts of the supply chain. In this time of rising costs and focus on the environment, efficiency is the key to competitiveness at the company level. Information The top supply chain issue in China is information sharing. Ideally, supply and demand are linked through the sharing of information and data, but in China, the industry's sharing of information is still far from optimal. To improve business processes and make further efficiency gains, information must be shared more promptly along the supply chain. This idea is new to many businesses in China's supply chain, however, and many manufacturers still maintain an in-house logistics division instead of outsourcing logistics and focusing on their core business. As awareness of the benefits of outsourcing grows, more companies are realizing that they can outsource the logistics function and are hiring third-party organizations to streamline their logistics and distribution processes, as well as to assist with information sharing and data management systems. In the next five years, many Chinese manufacturers will improve efficiency by outsourcing non-core functions, and the biggest efficiency gains will likely stem from the outsourcing of logistics and information technology functions. Balance of supply and demand Second, the balance (or imbalance) of supply and demand affects global supply chain efficiency. New business ventures have been flooding into emerging markets like China and India in waves. These fluctuating waves of investment—and the demand they create—have disrupted supply chains, resulting in the unpredictable supply of some products and the rise of a wide range of logistics services that vary in quality. To reduce uncertainties, the industry needs to adopt international best practices in supply chain management, such as ISO 28000:2007, a recent international standard for supply chain security management systems. Such standards will help emerging markets like China keep their competitive edge. PRC policy In China, policies change rapidly and often without adequate time to prepare for implementation. Last year's value-added tax (VAT) rebate cuts—designed to discourage low-end, polluting products—and other new rules are now squeezing low-end manufacturers and spurring changes in the supply chain. For example, some chopsticks for the Japanese market, previously made in China, are now made in Russia because of regulations aimed at halting deforestation in China. From Russia, the chopsticks will be exported to Dalian, Liaoning, where they will be enhanced with small value-added services in bonded zones. This process is called "simple circulation processing" and is relatively new to the market. After that, the chopsticks will go directly to Japanese supermarkets. In late July 2008, some of the export VAT rebate cuts were reversed—another example of China's constantly changing policies. Current government policy encourages the creation and manufacture of innovative, high-value products. China is also creating stronger incentives for companies to move inland in an effort to reduce the disparity between coastal and inland areas and to create new, innovative organizations in research and development as well as in the information technology sector. Jurgen Reinderink is secretary and treasurer, the Council of Supply Chain Management Professionals China, and marketing director, EH SCM Group. He is currently based in Hong Kong. Rich Products Corporation Kevin Malchoff is president, International Business Group, Rich Products Corp. CBR Assistant Editor Dan Strouhal recently interviewed Malchoff about Rich Products' cold-chain logistics operations in China. CBR: What unique conditions does Rich Products face as a provider of cold foods storage and transport in China? Malchoff: As we began to expand our presence in China in 1998, we faced a number of challenges. The country's road and rail infrastructure was just beginning to develop, and it is still developing today. We also found it difficult to find a logistics business with enough cold-enabled trucks to support our growing business. Finally, we needed a warehouse network to ensure our products would be stored and handled safely, while maintaining superior quality. CBR: How has Rich Products adapted to these conditions? What does the company do differently in China? Malchoff: The challenges I just mentioned, and our desire to rapidly grow our food business in China, drove us to acquire a majority interest in Kangxin Logistics (Tianjin) Ltd. Co. (KX Logistics), a cold-chain third-party logistics company based in China, in 2003. In forming our joint venture relationship with KX Logistics, we received the benefit of a partner who had been in the business for years and a leader, Wei Gao (current KX Logistics general manager), who was passionate about the cold-chain logistics business and had already developed a solid customer base. We also gained access to a state-of-the art fleet of cold-enabled trucks that keep our products at the correct temperatures; trained drivers to deliver our products to our customers on time and in great condition; and a network of refrigerated and frozen warehouses in strategic locations throughout China. Since then, we have enjoyed a successful partnership, which has resulted in significant growth. Today, KX Logistics is the leading cold-chain third-party logistics company in China. We have a multinational customer base, more than 350 associates and warehouses, and offices across China. CBR: Rich Products' operations cover more than 300 cities nationwide. How has the company overcome the variations in geography and infrastructure differences from province to province? Malchoff: In each province, we have team members who are residents of the local cities and who understand the local customs, as well as the unique needs of our local customers. We also learned early on that most laws in China are not created at the national level. Instead, each province is responsible for the creation and enforcement of its own laws and regulations. Therefore, it is critical that our people in each province understand the local laws and regulations and ensure we remain in compliance. CBR: In May 2008, Rich Products and KX Logistics opened a state-of-the-art refrigeration warehouse in Beijing. Has the warehouse experienced any difficulty since opening? Malchoff: We have not experienced any significant problems to date. I attribute our success in this regard to our experienced operations and engineering staff that has learned a great deal from building and opening warehouses in other cities across China and in other markets. We have also developed a first-class associate training program, which ensures we have the proper focus on product and worker safety on a day-to-day basis. CBR: How will China's cold-chain logistics change in the next 5 to 10 years? Malchoff: Demand for frozen food products will continue to grow, driven by an increasing focus on food safety and an emerging middle class with more discretionary income to spend on convenience items. Likewise, the cold-chain logistics network will need to expand to meet the growing demand for frozen food products, which bodes well for KX Logistics. We believe that the services KX Logistics provides will allow multinational manufacturers of frozen and refrigerated foods to grow at an accelerated rate in China. Bradley A. Feuling is the CEO of Kong and Allan and is based in Shanghai. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion. Further Reading The Sales and Distribution Revolution Managing Brands through Supply Chain Visibility China: Top Global Supply Chain Partner FICE and the Liberalization of Distribution in China Intermodal Revolution China's Evolving Transportation Sector Copyright 2008 US-China Business Council Top of Page Table of Contents
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