third-party logistics— key to rail freight development … · third-party logistics— key to...

32 Japan Railway & Transport Review 29 • December 2001

Third-party Logistics

Feature

Copyright © 2001 EJRCF. All rights reserved.

Third-party Logistics—Key to Rail Freight Development in China

Guo Jianhua

Hauling coals on Datong–Qinhuangdao Line (China’s Railways Press)

Introduction

In light of today’s trends in logistics, thisarticle analyzes the special role andfunctions of logistics from both micro- andmacro-economic viewpoints, pointing outthat third-party logistics is the key to futuredevelopment of rail freight in China. Itexamines the feasibility of and necessityfor outsourcing China’s rail freight, andoutlines a concrete plan.Before the 1970s, the term ‘logistics’ washardly ever used in economic studies inChina. Research on logistics did not startuntil the early 1980s when the conceptwas imported from Japan. After 20 yearsof research and implementation, logisticshas become a pivotal element in China’seconomic development, not to mentiona valuable source of corporate profits.

Supply Chain Management—Core of Modern Logistics

The study of logistics in China originatedwith the material management system.However, since the concept of logistics isstill vague, many people still confuselogistics with material management.Logistics is composed primarily offunctions such as transportation,warehousing, packing, shipping,customized processing, delivery, logisticsin format ion serv ices , and o theroperations. However, it is not a mereaggregation of the above-mentionedfunctions and activities. Today, logisticssynthesizes these relatively independenttraditional functions into a closely linkedsupply chain. It employs an integratedmanagement approach using modernmanagement concepts, methodology, andtechnological tools. Supply chainmanagement is the backbone of today’slogistics services.There is a major difference betweentraditional and modern logistics. Modernlogistics is not just a process made up of

a series of activities. More importantly,it is the process of a logistics providerparticipating in the management andadministration of a manufacturer ’sbusiness. From the viewpoint of themanufacturer’s customers, the logisticsprovider designs the logistics plan andoffers comprehensive services related tothe supply chain. While reducing theoperation costs and maximizing theoverall profit for the manufacturer, thelogistics provider also creates a profitmargin for itself. There is a fundamentaldifference in the perception of modernlogistics theories and traditional logisticsconcepts. For example, in order toinc r ea se r evenue i ncome f r omwarehousing, a traditional warehouseoperator holds as much inventory aspossible for as long as possible.However, when warehousing functionsas a link in modern logistics, the aim isto minimize inventory and speedturnover. A modern warehousingoperator tries to achieve almost zeroinventory for customers while striving totransform its facilities from a simple,p a s s i v e s t o r a g e s p a c e i n t o acomprehensive and dynamic distributioncentre, with the ult imate goal of

optimizing the whole logistics process.A traditional logistics operator manageswith the objective to maximize profitsand minimize operation costs. However,a modern logistics operator aims to offerservices that meet customer needs,optimize overall performance of logisticsfunctions, and maximize profits andminimize costs across all logistics activities.Thus, modern logistics is about serviceand integrated management of the wholesupply chain.

Unique Position of Logistics inMicro- and Macro-economics

From the micro-economic v iew,companies have little room to manoeuvrein cutting production and sales costs asproduction technologies have improvedand management know-how has grownon a global level. However, there is stillample potential to cut costs in logisticsoperations such as transportation,warehousing, delivery, and inventory.Thus, companies begin to change theemphasis from the dominance of capitaland product differentiation to logistics.In general, logistics costs are a significantpart of operating expenses, accounting

33Japan Railway & Transport Review 29 • December 2001Copyright © 2001 EJRCF. All rights reserved.

for 5%–35% of sales revenue. Today’sintegrated supply chain has madelogistics management a priority for manycompanies. In the early 1960s, Americanmanagement specialist Peter Derukedescribed logistics as the ‘dark continent’of economic development, the ‘lastfrontier for cost reduction,’ and the ‘thirdprofit source.’ Generally, managersemphasize cutting costs as the first sourceof profits and improving productivity asthe second source. Wu Bangguo, theVice Premier of China’s State Council,also pointed out that today’s logistics hasb e c o m e a n a d v a n c e d f o r m o forganizat ion and a managementtechnology. In addition to cutting costsand raising productivity, logistics iswidely recognized as an important sourceof revenue.From the macro-economic viewpoint,China’s economy and industrial structureare at historical turning point, requiringadjustment and integration. Most ofChina’s traditional industries are inf inancial di f f icul ty due to f iercecompetition. The malfunctioning supplychain has become the major weak linkof industrial development and manyindustries are gradually shifting the focusof their competition to distributionchannels. Since logistics spearheads theentire supply chain, there are greatexpectations that revitalization of China’slogistics will resolve the widespreadproblems arising from the decentralizedand divided distribution. Modernlogistics can open the door to China’sfuture industries as well as to economicintegration. Development of logistics isa prerequisite for overhauling China’seconomic structure. In a plannedeconomy, logistics and railways are quitesimilar because they are both arteries ofthe national economy. Industries that cangrasp the opportunities offered bylogistics will steer the Chinese economyinto the future.

Future Third-party Logistics

Logistics is an unavoidable part of allbusiness. A company can perform its ownlogistics (self-operated logistics), obtainoutside logistics services, or outsourcelogistics functions to a logistics company(third-party logistics).Logistics management has become aspecialized field as markets have becomemore extensive. Consequently, manybusinesses favour outsourcing theirlogistics functions to specialized third-party logistics providers. In doing so, theyfree themselves to concentrate on theircore business, while making full use ofthe specialized knowledge, technology,and information networks of the third-party providers to obtain services orproduction factors that are not availablewithin their own organizations.At present, third-party logistics providershandle 57% of logistics services in theUSA and about 80% in Japan. Third-partylogistics providers include warehousing,transportation, and logistics. Before the1950s, only third-party warehousing andthird-party transportation were common,but today, third-party logistics hasbecome an industry leader that shouldersmajor functions.Third-party logistics providers arecharacterized by the fact that not onlydo they provide customers with physicalmovement of goods, they also engage inthe customers’ overall corporate strategicand operational management. In orderto cut the total costs of logistics and toensure proper functioning of the supplychain, they put themselves in thec u s t o m e r ’ s s h o e s t o d e s i g ncomprehensive logist ics systems,formulate general plans for managing thesupply chain, and take charge ofoperational decisions and activities.Third-party logistics providers play a dualrole by designing the logistics systemsand performing the logistics operations.

Consequently, the relationship between athird-party logistics provider and thecompany it serves is both long term andcollaborative, and is not based onpiecemeal operational activities. Suchrelationship creates a win–win situationbecause it guarantees the companystability, systematization and continuity inthe planning and management of itssupply chain, while creating a stable,long-term customer base for the logisticsprovider.Third-party logistics is growing rapidly inEurope. For example, the Germanlogistics market totals US$34.6 billion andthird-party logistics providers have23.33% of the market worth overUS$8 billion. The figures for otherEuropean countries are shown in Table 1.To summarize, third-party logisticsaccounts for 10%–35% of the wholelogistics market in Europe, a figure that ishigh compared to other countries.

Feasibility and Necessity forThird-party Logistics in

Chinese Rail Freight

Logistics is a new concept for mostcompan ies in Ch ina . The twoconventional production models of ‘large

Table 1 Third-party LogisticsMarket Share in Europe

France 26.9%

UK 34.5%

Italy 12.8%

Spain 18.0%

Netherlands 25.0%

Belgium 25.0%

Austria 18.0%

Switzerland 22.0%

Denmark 20.0%

Finland 20.0%

Ireland 24.0%

Portugal 16.0%

Greece 11.0%

Luxembourg 25.0%




Large gantry crane in busy freight reloading yard at Manzhouli Station on Russian border (China’s Railways Press)

scale and fully fledged’ and ‘small scaleand fully fledged’ have created a self-sufficient structure that has stifled thelogistics market. However, since openingthe door to reform, the Chinese economyhas sustained rapid growth over 20 years.The resultant dramatic improvement inproductivity has created a buyer’s marketthat further aggravates competition.Competition between businesses hasexpanded from manufacturing to non-manufacturing industries, offering logisticsmanagement a window of opportunity forcompanies to cut costs, upgrade servicequality, and create an competitivelyadvantageous position. In China today,after a product leaves the factory, thedistribution cost including the variouslogistics functions such as shipping,warehousing, transportation, and deliveryto the end user is about 50% of the price.In the case of fresh fruit and vegetables,perishables, and some chemical products,i t can be a s h i gh a s 70%. I nmanufacturing of automobile parts inChina, warehousing, shipping, andtransporting of raw materials and

component parts occupies more than 90%of the manufacturing time. Large amountsof raw materials, components, andfinished goods are held as inventory at theproduction and distribution ends. Suchwastefulness of t ime, money andinventory presents a huge opportunity forlogistics development.

Commonality of modern logisticsand traditional rail freightModern logistics systems span manyindustries and operations but the two mostimportant are transportat ion andwarehousing. Many well-known logisticscompanies in the USA, Europe and Japanhave their origins in transportation andthere are strong ties between logistics andtransportation. The transportationindustry is the basic logistics carrier andtransportation costs represents a large part( abou t 45%) o f log i s t i c s cos t s .Rat ional izing t ransport methods,minimizing costs, shortening transit times,and delivering products punctually andaccurately are all prerequisites for cuttinglogistics costs and improving logistics

efficiency. Transportation is the core ofmodern logistics and barrier-free railfreight is a key part of modern logistics.

Providing infrastructure fortransition to modern logisticsRailways are the main mode of transportin China where they enjoy an extensivenetwork, adequate warehousing, well-located stations, large-scale containersystems, special transport services, courierservices for luggage and parcels, etc. Thefacil i t ies and equipment used bytraditional rail freight are well positionedto develop modern logistics. Furthermore,railways have comparatively high brandrecognition in the domestic market, askilled staff, a stable client base and adominant market share. The advantagesof railways are unlikely to be matched byother t ranspor t modes , logis t icscompanies, and newcomers to thelogistics industry for a long time.The top priority in developing China’slogistics is building large-scale integratedlogistics centres offering services over awide area. Since railways dominate long-distance transport of bulk freight, existinglarge railway hubs and marshalling yardspresent an ideal infrastructure for buildingintegrated logistics centres.Clearly, modern logistics in China doesnot mean the high-tech fully automatedlogistics systems found in many overseascountries. Logistics systems in China mustmatch the current state of China’s transportindustry while accommodating worldtrends in logistics. The major differencefrom modern logistics overseas is thatChina must pursue modernization of boththe organization and management ofmodern logist ics rather than justmodernization of facilities and equipment.

Requirements for favourabledevelopment of rail freightModern logistics emphasizes provision offully-fledged services to customers ratherthan just physical movement of goods.


Therefore, development of rail freight inthe direction of third-party logistics couldgreatly improve rail t ransport byintroducing new management conceptsand enhanced services. Furthermore,modern logistics is a high-technologyindustry based on information technology(IT) and the Internet. It requires systemsfacil i tating information exchangeinc lud ing advanced e lec t ron icstechnology (global positioning satellite(GPS) systems, telecommunications, bar-coding, electronic data interchange (EDI)system) automated warehousing,automated shipping, inter-modaltransport, etc. As a result, it has thepotential to drive rail transport, especiallyrail freight, to new heights.

WTO Membership to triggersevere competitionIn the last 20 or so years, famousinternational shipping companies likeP&O Nedlloyd and Maersk-sealand havesuccessfully entered the field of integratedlogistics services. They have developedlarge-scale operations and have gainedthe high ground in terms of networks, IT,management know-how, and skilledworkforce. These pioneers have turnedtheir eyes to China’s rapidly expandinglogistics market and have formedrelatively stable partnerships with Chineseand fo re ign jo in t ven tu res andmanufacturers using foreign capital.When China becomes a member of theWorld Trade Organization (WTO), itslogistics market will open up rapidly andforeign companies wil l use theirexperienced workforce and financialadvantages to quickly establish logisticsnetworks and capture market share.Nevertheless, establishing any large-scalelogistics systems in China will take timeand Chinese railways might still have theadvantage of a long tradition in domesticland transport. Today, Chinese railwaysare faced with a rare opportunity and asevere challenge.

Action Plan for China’s RailFreight Transport to Develop


Since China opened up to reform, thegovernment has augmented investment inrailway construction and increased thenumber of track-km by opening newrailway lines, rapidly improving thetransport infrastructure and raisingcapacity. However, overall railwaydevelopment has still not caught up withthe demand of China’s economy. As aresult, the transport capacity of railwaysin China is still relatively constrained; thelevel of transport companies is still low,especially in the level of specializationand lack of efficiency. Chinese railwaysstill lack the mindset for logisticsmanagement and fall short of integratedtransport networks with large-scaleintegrated logistics centres, distributioncentres, and systematic and rationalplanning. Therefore, there is still a largegap between China’s rail freight transportand third-party logistics benchmark. Tomake steady progress in closing the gap,China needs to be systematic.

Promote third-party logistics forall rail freightThe standard of quality for today’s logisticsservices is based on delivering the rightproduct, in the right place, in the rightquantity, at the right time, and at the rightprice, or the so-called ‘Five Rights.’Under a planned economy, Chineserailways transported mainly bulk freightsuch as coal, minerals, and agriculturalproducts. Rail freight only meant physicalmovement of goods—services andlogistics were out of the question.Following the transformation of China’ssocio-economic structure, the productlogistics market and the transport markethave also undergone fundamentalstructural changes. Today, they provide awide range of services including deliveriesto supermarkets, shopping centres, andchain stores. Logistics services aresupplied to manufacturers and companiesselling automobiles, electric appliances,daily necessities, clothing, etc., along withtransportation, warehousing, and deliveryof fresh, frozen and refrigerated foods.These are the areas with the greatestgrowth potential for specialty logisticsservices. The market demand has

Freight train passing through environmentally sensitive sand dunes on Baotou–Langzhou Line(China’s Railways Press)




The new Eurasian land bridge starts from Lianyungang Harbour on Yellow Sea (China’s Railways Press)

changed from a few low-value productvarieties in high volumes with few batchesin a long cycle, to many high-valueproduct varieties in low volumes withmany batches in a short cycle.D u e t o t h e a b o v e - m e n t i o n e dcharacteristics and market demand,nat ional special ty t ransportat ioncompanies set up after the separation ofrailway infrastructure from operationsmust take the lead in the direction ofmodern logist ics. Transportationcompanies in containerized transport,courier services carrying luggage andparcels, specialty transport, and railexpress will find themselves faced with aspecific and elaborately divided marketand customer groups. These customerswill require transportation companies tooffer not only door-to-door delivery andother basic services, but also value-addedlogistics services, using them as a standardto gauge the service quality. Due to thediversity of product categories and thespecial nature of products, it is convenientand necessary for these companies to finda market niche by offering single-typecustomized transport services. As a

consequence, they will integrate into thesupply chains of manufacturing companiesand grow into third-party logistics providerscapable of offering customized as well asgeneral logistics services.

Restructure rail freight to usetransport agentsMost of China’s rail freight is still basedon direct consignment by customers. Thisrelatively old-fashioned method is a majorimpediment to rail freight development.I must say Chinese railways have madegreat efforts to reform and simplifyconsignment procedures with excellentresults. However, the problem withcomplex consignment procedures has notbeen resolved completely. We must alsorealize that as the modern transportstructure becomes more and morespecia l ized and complex, manyprocedures cannot be simplified. Settingup a transport-agent system is the onlyway to get to the root of the problem.Transport agents serve as an intermediarybetween the cargo owners and thecompanies supplying the transportservices. A transport agent takes care of

all the procedures including consignment,interconnection, multiple-journeytransport, and delivery to the finaldestination, fulfilling the goal of oneconsignment, one account settlement, onecontract, and one freight bill to the finaldestination. The transport-agent systemcan bring a fundamental change to therelationship between cargo owners andtransport companies. Throughout theentire transport process, cargo owners andtransport companies will no longer needto deal with each other directly, but cango mainly through agents providingservices to both parties. The agents canalso create profit margins in transport bycutting costs through economies of scaleand specialization.From the above, we can see that directconsignment by owners only performs therailways’ function of physically movingthe goods. The transport-agent systemadds the service function to the physicalmovement of goods.In fact, modern logistics services alreadyinclude the transport agent’s functionssuch as offering services in transportconsul ta t ion, select ing the mostappropriate combination of transportmethods, customized routing, consigningcargoes on customers’ behalf, andproviding door-to-door delivery services.The services provided by transport agentsconstitute an important part of the modernlogistics services, a necessary step that railfreight companies must take to advanceto modern logistics. For this reason,China’s rail freight must first complete thetransition from the direct-consignmentsystem to the transport-agent system, andthen change direction to modern logistics.

Building logistics base usingstation freight terminals andenhancing value-added servicesInfrastructure must be upgraded in tandemwith growth in logistics. Logistics basesor indus t r i a l pa rks p rov ide theinfrastructure for implementation of


intensive logistics, and serve as theincubator for nurturing modern integratedlogistics. The construction of a centralizedand specialized logistics base can provideservices to logistics companies in the areaand attract more newcomers.The freight terminal at a Chinese railwaystation is the centre for collecting anddispatching goods and for exchange ofinformation. Building logistics bases atstation freight terminals would be effectivein terms of location and time. In additionto its traditional functions, a station freightterminal can make use of its advantage intraditional shipping and warehousingfunctions to expand the scope of servicesto augment the added-value of products.These services include product packaging,labelling, assembling, repair, processingof returned merchandise, and simpleproduct processing. The availability ofsuch services makes logistics truly a partof the customer’s manufacturing and sales.By the same token, information exchangecentred on station freight terminals mustalso undergo a value-adding process tochange from dispersion to concentration.Station freight terminals will have to beequipped with large-capacity, high-performance electronic informationsystems to provide a basic informationplatform so that they can integrate,p roces s , manage , and t r ansmi tinformation from various sources such aslogistics companies and customers.

Maximizing the use of informationresources will enhance the value-addingfunctions of logistics.

Speeding investment in railwayinformation infrastructureModern logistics uses cutting-edget e c h n o l o g y a n d s o p h i s t i c a t e dmanagement to provide services. As thescale and extent o f product ion,distribution, and sales expand, thetechnology, equipment, and managementof logistics also become more advanced.Technologies related to computers,telecommunications, mechatronics, andvoice recognition are used widely inlogistics management. The world’s mostadvanced logistics systems use GPS,satellite communications, radio-frequencyrecognition, and robotics to achieveautomation, mechanization, paperlessoperation, and artificial intelligence.These technologies are being perfected inthe West. Lately, a considerable amountof logistics and distribution technologieshave been introduced into China and have

Guo Jianhua

Dr Guo has a degree in engineering and is a post-doctoral student of economics at Guanghua School

of Management at the University of Peking. He is conducting research in transport economics, industrial

economics, and public (government) economic management under Professor Li Yining, a world-

famous Chinese economist.

Sino–Mongolian Railway at Erenhot, an important international reloading yard onMongolian border (China’s Railways Press)

gained wide acceptance. They includebar-coding, computerized informationmanagement technology, EDI, materialsrequirements planning (MRP), etc.Chinese rail freight is speeding up its effortto construct and apply informationsystems. Based on the transportmanagement information system (TMIS),it is optimizing and integrating the variousconventional information systems toestablish an automatic freight wagonrecognition system. It is also leadingcontainer transport companies and ChinaRailway Express in research and testinge-commerce models and logisticsmanagement for container transport, railfreight, and warehousing. This willprovide the information and technologyframework to enable traditional rail freightto develop and integrate into modernlogistics. �

Chinese and Russian crew checking reloading tickets (China’s Railways Press)

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