As the largest and still the fastest growing car market in the world, carmakers in China are hoping to develop supply chains in its vast interior and western regions, with the government investing billions

Fiat’s Jack Cheng is a perfectionist, as equally for music as he is for his supplier base. His search for the perfect pitch of synchronised sound has lead to an ever growing collection of high-end guitars (around 15). Recent acquisitions include a new Gibson from Japan and another from an upstart in Taiwan. But quality and perfection can emerge from the least expected source. The guitar from Taiwan “is real good,” says Cheng.

And so too it goes for sourcing in China. As chief procurement officer for Fiat’s global sourcing office, and vice president of Fiat Group China, Cheng searches deep in Asia’s interior for the best suppliers.

But although it has become the world’s largest car market this year, and is already the largest warehouse of automotive parts, it remains an emerging market with substantial supplychain issues, especially beyond the modern and expanding infrastructures in Shanghai or Beijing. But as Cheng knows better than most, success in this market depends on a supply chain that stretches through the hinterland. And to do that, purchasing chiefs like him must have better visibility over logistics costs.

That is one reason why Cheng recently made the decision to pull his purchasing and logistics divisions together, while separating the commercial and technical-minded teams.

“I put the purchasing and logistics together as they are more commercial, and the quality and engineering together as they are more technical,” says Cheng.

At the very beginning of the RFQ (request for quotation) stage Fiat’s logistics manager Candy Zhang provides an estimate of the cost of sourcing a part from a certain country or area. She calculates what government tariffs, logistics, packaging and storage costs are involved. But China’s infrastructure is patchy and so it tends not to be a smooth calculation.

“We are currently doing a study to understand logistics costs, and the best solution for export [ranging] from Taiwan and Korea to South America and Europe,” says Zhang.

This streamlining of purchasing to add the cost of transporting a part has become a trend and a must for the industry in China.

“Traditionally the purchasing group is responsible for ‘per piece price’ but now it is asked to be responsible for ‘total cost,’” says Sanjay Malhotra, regional manager, supply chain Asia at TRW Automotive. “So the cost of per piece price could be advantageous but depending on where the piece comes from may not necessarily be beneficial.

“Now freight cost plus per piece price has to be considered by the purchasing team. So even if purchasing does a good job on price negotiation, if the freight cost and custom duties are high it is not beneficial. From a design perspective, landed cost now becomes the responsibility of the purchasing team,” he says.

Low visibility

In the major centres, China is modern and computer literate with electronic tracking systems, new roads and roll-on, rolloff ports, while the contrast could hardly be more different in the vast interior, where many suppliers can be found.

“Different parts of the region are at various development levels which affect where we are in the development of our logistics operating system. The current logistics market in China is still emerging,” says Jeffrey Richards, Asia Pacific logistics director at Delphi Automotive.

For TRW’s Malhotra, this poor visibility over the logistics flow needs to be addressed. “In many cases a lack of information causes more panic,” he says. When goods have been picked up from a supplier somewhere in China’s interior, visibility of exactly what is in the truck and the truck’s movement is low. “In-transit becomes a black hole,” he says.

Malhotra calls for an extensive EDI system to solve the problem. But it is an investment and not every logistics company in China wants to increase capital costs. “It will have an initial cost but it will also reduce a lot of hidden costs building up in the system,” Malhotra says.

Justin Barrow, director of business development for the Asia-Pacific region at Penske Logistics, agrees: “Only a few carriers possess a national footprint, and last kilometre pickup and delivery can be a critical challenge for some shippers when reaching more remote locations. The demand for local logistics providers to innovate and incorporate sophisticated technology into their solutions is starting to increase.”

According to Barrow, it is challenging to locate reliable domestic trucking providers. When there are loads involving several or more brokers, control issues come into play, as some providers are not accountable for claims and compliance with government transport regulations.

But not everyone believes that more IT is necessary to address such problems. “If you talk about a track-and-trace system, say in Shaanxi province, well, it just doesn’t make sense,” says Candy Zhang. For example, a truck with a 20ft container may not even be able to get through a particular route. For Zhang, the main method – or ban fa, in Mandarin – for the existing environment is simple human communication.

“Frankly, in China the supply chain relies more on humans than a system,” she says.

Delphi’s Richards agrees that the IT systems in China are still insufficient for his company’s needs. “The infrastructure and assets are improving in China, but we still don’t have the repeatability and tracking that is needed to truly optimise Delphi’s lean supply chain,” he says.

A crowded market starts to spill inland

The logistics market in China has also suffered from overcrowding, according to manufacturers. It grew too much, too quickly. It also inherited the fractured shape of China’s OEMs, where there is already a high number of carmakers and many with in-house logistics companies. But now that exports have fallen, the marketplace is pushing out the inefficient players.

“In the last ten years a lot of players have entered the logistics market and the method of the day was to pick up and run and basically grow with the market,” says Malhotra. But many of these companies lack experience managing inventory or providing tracking systems, he adds.

“I think the financial crunch has really rationalised the supply chain,” says Fiat’s Jack Cheng.

But what is poor quality in the cities might be a big improvement in the hinterlands. As global demand for products from China has dropped around 35%, many previous truckers and logistics suppliers from port areas such as around Shanghai have moved in-land, pushing a surplus workforce into China’s interior and raising the standards of service in those regions.

Go west, says the government

China’s government is also pushing the development of China’s interior with a special drive to develop infrastructure in and around 4th tier cities as well as in western China.

A tier one city in China would be Beijing or Shanghai, while industrialised centres like Nanjing, Suzhou or Chengdu would be considered tier two. A third tier city is Kunshan, a small but strong manufacturing hub near Suzhou and Shanghai, while fourth tier cities are agriculturally-driven places like Nanchang, the capital of Jiangxi Province.

The drive west and inwards into China means Sichuan province at the upper end of the Yangtze river is booming with investments for railway hubs, inland ports and manufacturing plants. Construction on a new RMB1.3 billion ($190m) port in Yibin at the confluence of the Yangtze, Minjiang and Jinshajiang rivers began in 2008.

“We plan to have four container ports and three ro-ro berths,” says Yang Lei, spokesperson for Shanghai International Port Group. SIPG has invested in the joint venture to develop the Zhicheng port in Yibin city, Sichuan province. By 2030 the port will cover 75km of coastline with 11 different port areas and will grow capacity to 4m TEUs.

The new Chengdu Railway Container centre in Sichuan’s capital city is expected to open by the end of 2009. Designed to have an annual handling capacity of 2.5m containers, the station and logistics park are expected to form the largest integrated sea-rail inland port in central and western China, according to the Chengdu Municipal Government.

But for logistics planners and network designers these inner areas remain problematic.

“With more and more manufacturing being located towards inland western areas away from the coast of China, domestic transportation can be a larger challenge for international exports as well,” says Penske’s Barrow.

This development push into China’s interior will help the entire system in the future. Once the roads are uniform and technology is widespread, transparency and visibility will shine through.

And as this happens, Cheng expects logistics costs from China’s interior to come down. “It’s a zero sum game. If you have 2 million labourers on the coast going inland as exports go down, I expect prices to come down as there are surplus logistics providers in business,” says Cheng.

Plus as new rail and inland container networks develop, intermodal transport will increase. “As the government is improving the infrastructure that will promote the usage of other alternative modes besides trucking, for example rail, water etc.,” says Delphi’s Richards.

“Penske expects that rail will have a significant impact over time,” says Barrow. “Intermodal usage will definitely increase in the future, and it will have a positive impact on long-distance transport. Rail transport is key for China’s infrastructure investment.”

Delphi’s Richards says the company has recently switched to using a rail network. “Government has done a great job in leading infrastructure improvement. Delphi recently moved a major lane to rail after the government completed an infrastructure improvement programme which reduced transit time and variation,” he says.

Regulation and trade disputes

China’s regulations have slowly become easier as practices become more international, systems are upgraded and more people are able to speak English.

“Five years ago the customs services asked for everything, they had no records. But now they have all transactions and details spanning the last three years in their computers,” says Candy Zhang. It also means the government has prioritised getting information systems at major ports improved.

“The government is opening up and improving more ports to international standards, while custom clearance times are reducing drastically,” says TRW’s Malhotra. “The government has done a pretty good job reducing custom duties which has helped technology come to China.”

Indeed new ports with roll-on, roll-off facilities have been opened with bonded warehouses where cargo can be directly exported with no need to pay duty.

But understanding coding systems still creates problems for new suppliers and this can clog up the smooth flow of goods from China. For example, the Harmonised Commodity Description and Coding System (HS) of tariff nomenclature is an internationally standardised system classifying traded products. The HS is a six-digit code but individual countries may extend HS numbers to eight or ten digits for customs purposes.

The HS code system in China is a ten-digit code. The first six numbers are recognised internationally. But if a supplier puts the wrong HS code it can lead to a higher cost because automotive parts exported from China are given a 13% tax rebate, and so putting a non-automotive HS code means no rebate. Meanwhile, international trade tariffs on some automotive goods exported from China mean they now have higher tariffs than others.

Keeping up-to-date on recent tax rebate schemes, plus a working knowledge of tariffs on goods, is imperative in China as logistics and purchasing teams look for the best cost in the supply chain.

“It is important that we are knowledgeable on current tariffs and aware of future policy directions,” says Richards. This knowledge is especially important as other governments attempt to discourage the import of Chinese made auto parts.

The US trade dispute brought to the forefront by a petition by the United Steel Workers Union has been approved by the Obama administration and now forces tariffs of 35% on Chinese-made tyres. In 2008 China’s tyre exports to the US were worth $2.2 billion (RMB15 billion).

In retaliation, the Chinese government has recently begun moves that could lead to import taxes on cars imported into China by GM, Ford or Chrysler built in the US. Similar to the tyre regulation, such taxes would be more symbolic than detrimental, since relatively few US-built cars by these OEMs are sent to China (7,000-9,000 units per year in total). But a tit-for-tat trade battle does not bode well with the US population in an increasingly protectionist mood.

The US is not alone in enforcing tariffs on goods made in China. Brazil also enforces tariffs of around 50% on tyres and the EU has a 60% tariff on seamless steel tubes imported from China which it says can be made in Turkey. For global companies, the direction of future trade barriers is a worry.

With this in mind, automotive suppliers sourcing from China need to make sure they are not hit with sudden cost hikes. “Tariffs can be a significant total cost driver and it does impact sourcing and network decisions,” says Delphi’s Richards.

It’s a game of second guessing as companies try to foresee which parts might get high tariffs in the future. It calls for a continuing integration between logistics and procurement departments to bring better visibility over the potential cost of sourcing a product before actually pushing beyond the RFQ stage.

As the country’s infrastructure improves and roads develop to international standards, soon it may be easier to move across this vast nation. But not quite yet, and until then China is sure to require its own unique approaches.