Chapter 1: Introduction
1.3 Methodology and scope
The thesis will focus on analyzing 3PL industry in China including such aspects as business strategies of foreign entrants and key factors determining their success. In order to examine the attractiveness of china's 3PL industry Michael Porter's five forces model enhanced by adding complementors to the analysis will be applied. The value net model introduced by Adam Brandenburg and Bary Nalebuff will be used to examine the success strategies of foreign companies operating in the 3PL industry in China.
Data and information used in the thesis were collected from many sources such as:
discussion with the thesis advisor, publication and market research, papers related to industry analysis, interviews with key people in the 3PL industry as well as personal knowledge of the sector.
18 1.4 Thesis structure
The thesis will consist of five chapters. Chapter one includes introduction of china logistics background, basic overview of 3PL business, motivation and objective of this thesis as well as methodology and scope of research.
Second chapter will introduce theoretical frameworks applied during the analysis.
Chapter three will be a thorough analysis of logistics industry in China, with particular emphasis on 3pl sector. Moreover, current trends in the industry as well as evolution of government regulations will be introduced in this part of thesis. Chapter four will be an analysis of market entry strategies and market positioning of foreign 3PL providers with particular focus on their M&A activities. Conclusion of the research as well as some recommendations for multinational 3PL providers operating in china will be included in chapter five.
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Chapter 2: Literature Overview
2.1. China Third Party Logistics Overview
Outsourcing of logistics operations is a very common practice in developed economies.
Hiring specialized 3PL firms to handle logistics activities enable companies to leverage their resources, spread risks and concentrate on issues critical to survival and future growth.
Outsourcing not only reduces the complexity of firms operations, but also significantly reduces capital investments. Along with China economic development, companies are growing in size and engaging in increasingly sophisticated activities. Moreover, due to gradually loosening restrictions for foreign enterprises competition on the market has risen significantly leading to higher pressures for costs optimization. Those changes of business environment together with increasing amount of 3PL providers has resulted in rising popularity of logistics outsourcing among Chinese managers.
2.1.1.Rising outsourcing ratio for both commercial and industrial enterprises
The chart below illustrates steady growth of logistics outsourcing quotient between 2005 and 2009 reaching 61,2% at the end of the period18.
Figure 2 - 1 Outsourcing rate of Chinese enterprises between 2005-2009
Source: NRDC and Nankai University
18 Li&Fung Research Centre, China's Logistics Industry Update, May 2011, found online at http://www.lifunggroup.com/eng/knowledge/research/china_dis_issue82.pdf
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Based on data published by NDRC and Nankai University, among the companies participating in the survey, over 70% outsourced at least half of their logistics functions by volume in 2009. In addition, 41,1% of enterprises included in the study outsourced over 80%
of their logistics operations to third party providers. Data collected by the survey reflects growing importance of outsourcing concept for both commercial and industrial enterprises in China. The fact, that majority of the companies turning to outsourcing does it with a
significant fraction of its logistics operations is a proof that once a firm had experience with hiring 3PL providers, the management quickly realizes its benefits and increases the volume of outsourced activities.
Figure 2 - 2 Proportion of logistics functions outsourced to total logistics volume, 2009
2.1.2 Types of Outsourced Activities
According to the survey, basic functions such as transport and distribution were the ones most often outsourced by the Chinese enterprises, with significantly less emphasize on more sophisticated activities such as logistics system design or inventory management.
However, based on information provided by the respondents this trend is likely to reverse in the upcoming years. When asked, what activities would be considered for outsourcing in the future, majority picked more advanced logistics functions such as logistics information
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management of logistics system design. This trend can be seen as another evidence of growing acceptance for logistics outsourcing among Chinese enterprises.
Figure 2 - 3 Types of logistics services outsourced, 2009
Source: NRDC and Nankai University
Figure 2 - 4 Types of logistics services to be outsourced in the future, 2009
Source: NRDC and Nankai University
2.1.3 Number of Logistics Service Suppliers
According to the survey conducted by NDRC and Nankai University Chinese enterprises tend to outsource their logistics activities to more than one supplier. Companies outsourcing to an optimal number of providers are able to reduce transaction and risk by increasing bargaining power. Moreover, they can use services of companies specializing in
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certain field of logistics. Based on the data provided by survey, it is observable, that more than 73% enterprises decided to outsource their logistics operation to 2 between 5 suppliers.
Only 15,8% hired more contractors, since bigger number could result in higher transaction costs and complexity.
Figure 2 - 5 Number of Logistics Service Suppliers
Source: NRDC and Nankai University
2.1.4. Profitability of logistics companies.
Figure 2 - 6 Profitability of Chinese logistics companies in 2009
Source: NRDC and Nankai University
Based on data provided by the 8th National Survey on Logistics Market by the NDRC and Nankai University, approximately 42 % of logistics firms reached a profit margin of 5-10%, whereas 27.2% indicated a profit margin between 3-5% in 2009. Moreover, according to the The 2010 National Statistical Survey Report on Logistics of Key Enterprises by the
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NDRC, National Bureau of Statistics (NBS) and CFLP Chinese logistics companies recorded average profit of 6.0% in 2009.
One of the most critical factors determining profitability of logistics companies is vehicle utilization rate. According to the survey In 2009, only 38,7% of the enterprises managed to fill over 90% of the capacity of their vehicles, whereas 70.4% of them exceeded 70% utilization rate. A decrease from 73.4% is observed when comparing to data from 2008.
Figure 2 - 7 Vehicles utilization rate of Chinese logistics companies in 2009
Source: NRDC and Nankai University
Warehouse utilization rate is an another factor with critical impact on profitability in logistics sector. According to the survey only 36,1% third party providers managed to use more than 90% of their warehouse capacity in 2009, whereas 73.9% of the surveyed
enterprises employed over 70% of the capacity, indicating a drop from 75.0% and 78,1% in 2008 and 2007 respectively.
Generally, logistics enterprises in China show rather low levels of profitability, however 2009 results were severely affected by the financial crisis. Due to sharp decline in demand many ships and trucks remained idle resulting in cost escalation and as a result, poorer financial performance.
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Figure 2 - 8 Warehouse utilization rate of Chinese enterprises in 2009
Source: NRDC and Nankai University
2.1.5 Scale of leading 3PL providers in China
Figure 2 - 9 Size of 3pl providers in China
Source: CFLP
According to data provided by CFLP, there were already 50 logistics companies with revenue exceeding 1 bln RMB in 2009, comparing to merely 34 in 2004. Total revenue of the top-50 logistics companies in China reached 450.6 billion RMB in 2009. Although, Chinese 3PL show strong growth in domestic market, only one of them - Sinotrans have entered the global top 10. However, if ranked by fleet size, 3 sea fright companies, COSCO Container L.
(中遠集裝箱運輸有限公司), CSCL (中海集裝箱運輸股份有限公司), OOCL (東方海外) are among 20 biggest container shippers in the world.
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Figure 2- 10 Top 20 logistics providers in china by revenue in 2009
Source: Li&Fung
Figure 2 - 11 Top 15 global 3PL providers by gross revenue
Ranking Enterprise Gross Revenue mln USD
1 DHL Supply Chain & Global Forwarding 30,486
2 Kuehne + Nagel 19,476
3 DB Schenker 18,999
4 Nippon Express 18,450
5 C.H. Robinson Worldwide 9,274
6 Ceva Logistics 9,091
7 UPS Supply Chain Solutions 8,670
8 DSV 7,587
9 Panalpina World Transport 6,887
10 Hyundai Glovis 6,303
11 Sinotrans 6,286
12 Bollore/SDV Logistics 6,163
13 Expeditors International of Washington 5,968
14 Geodis 5,578
15 Toll Holdings 5,303
Source: www.3plogistics.com
26 2.2 Five forces analysis
Five forces analysis is a popular model used during the decision process concerning entering an industry, and determining the positioning of a company within a sector. The framework helps to identify the levels of the competition and the potential profitability of the industry19. The five forces model was developed by a professor of Harvard Business School Michael Porter in the year 197920. It analyzes the impact of five competitive forces on the profitability of the industry. The model includes three horizontal competitive forces coming from potential entrants, substitutes, and established competitors as well as two vertical forces such as bargaining power of suppliers and customers. Although the relations between entities in different industries vary between one another, however the five forces which affect the level of rivalry and profitability of an industry are generally very similar. More detailed analysis of respective five forces will be conducted below.
19 Roger Bennett, Jim Blythe, December 2002, international marketing strategy planning, market entry & implementation, 3rd Ed. Kogan Page, Ltd,
20 Porter, Michael E. 1979. How competitive forces shape strategy. Harvard Business Review. March-April 1979, pp. 137-145.
27 Figure 2 - 11 Michael Porter's Five Forces Model
2.2.1Threat of new entrants
When return on capital in one industry exceeds the cost of capital, it will become attractive for outside companies to enter this industry21. The new entrants may become a threat by expanding the capacity and therefore leading to decrease of profitability of the industry. However, in majority of cases the new entrants are unable to enter the industry on the same conditions as the established firms did. According to Michael Porter‘s model, there are six major barriers that impede the expansion for new entrants. The higher the barriers are the higher the long-term profitability of the incumbent will be. Entry barriers consist of economies of scale, capital requirements, product differentiation, absolute cost advantages, distributions channels access as well as governmental and legal restrictions.
21 Porter, Michael E. 2004. Competitive Advantage, Free Press
28 Economies of Scale
Economies of scale arise when the cost of a product or service decreases as a result of extensive size of operations. When an industry is dominated by big players who conduct their activities such as production, service, financing, marketing or distribution on a large-scale the new entrants in order to successfully compete with incumbents will be also forced to enter on a large scale which may end up in high costs resulting from unutilized capacity in the initial state22. Economies of scale may become a huge barrier for potential entrants in some
industries. The automobile industry in which cost efficiency starts from producing at least 3 million cars a year, is a good example of high entry barriers sector.
Capital Requirements
When potential competitors plan to establish their presence in an industry, it often requires a substantial financial investment to gain the ability of competing with the
incumbents. The financial capital is mostly required to cover such expenditures like R&D and marketing campaign as well as to purchase fixed and current assets such as facilities or
inventories23. Obviously different industries require different amounts of capital, which mostly depends on the scale and level technological advance of the sector. For example the costs of developing new drugs significantly limits the number of potential entrants to pharmaceutical industry. On the other hands there are some industries where capital requirements are low, such as e-commerce.
22 Robert E. Hoskisson, Micheal A. Hitt, R. Duane Ireland, Jeffrey S. Harrison, August 2007, Competing for advantage, Cengage Learning,
23 Porter, Michael E. 1998. Competitive Advantage: Creating and Sustaining Superior Performance. Free Press
29 Absolute Cost Advantages
When entering a new industry new companies typically face cost disadvantage comparing to the incumbents. Absolute cost advantages are not connected with scale. They usually stem from better access to raw materials, company's experience, learning curve, favorable locations or government subsidies. A good example of such advantage are mining companies based in countries rich with mineral resources.
Product Differentiation
According to Michael Porter's analysis product differentiation boosts brand recognition and loyalty among the customers which create high barriers for new entrants.
However the importance of customers‘ loyalty to a brand varies from industry to industry. For example cigarettes or apparel sector will be characterized with high degree of customer brand loyalty whereas in case of garbage bags the level will be low. If the new entrants want to pursue comparable levels of brand loyalty that incumbents enjoy they will have to spend significant amounts of capital marketing campaigns in new markets24.
Access to Distribution Channels
Suitable distribution channels are a key factor determining the success of a product or service. They generally consist of distributors, wholesalers, retailers or e-commerce platforms.
Since the incumbents already posses favorable relations with distribution channels it is very difficult for new entrants to gain a significant presence, with forward integration of
distribution activities becoming the only feasible choice in some cases. Retailers may have not enough of free space to fit new product offerings and may not be willing to accept a risk of selling a product unknown in the market, that often includes fixed additional expenditures
24 Porter, Michael E. 1998. Competitive Advantage: Creating and Sustaining Superior Performance. Free Press
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related to promotion. Therefore, lack of access to effective distribution channels is one the main barriers for potential market entrants.
Governmental and Legal Barriers
In many cases the governments regulate the level of competition in the markets through various policies and laws. The restrictions may take form of licenses, standards or safety regulations that increase entry barriers for potential entrants. Such obstacles are very common in financial industry where a license from the related administration organs is required before the company can start its operations.
2.2.2. Threats of substitutes
According to Michael Porter's model substitute product is a source of threat for the company's profitability, since it significantly limits the price that can be charged for the goods, unless the enterprise is successful in product differentiation. This situation takes place because the consumers reservation price depends partly on the accessibility of substitute products25. The availability of substitutes increase the cost effectiveness of an industry simultaneously decreasing profitability of its players. The substitutes can be divided into three different groups: product-for-product substitution, substitution of need by a new product or generic substitution26. The severity of the threat generated by substitutes depends on such factors as the difference between the prices of goods, switching costs or consumer's propensity to substitute.
25 Porter, Michael E. 1979. How competitive forces shape strategy. Harvard Business Review. March-April 1979,
26 Johnson, Gerry & Scholes, Kevan, 2002. Exploring Corporate Strategy. Essex: Pearson Education Limited.
31 2.2.3 Rivalry between competitors
The level of competition between incumbents determines has a significant impact on the profitability of the industry27. In extreme cases the competition is so stiff that companies are forced to sell their products below the cost of production leading to industry-wide losses.
However, in some industries, the competition may occur mainly in form of advertising or product innovation. There are five key factors that determine level of competition between the incumbents in particular industry.
Concentration
According to Michael Porter, the level of competition is strongly affected by the number of competitors in the industry and their level of competence28. The competition is stiffer when the industry consists of a large number of similar sized players. On the other hand in the market dominated by a single firm the intensity of competition is low and the company has a significant level of freedom in its pricing strategy. When there are few players
dominating the market the intensity of competition is limited and cartels that set the price level may emerge. The concentration ratio of a industry may be measured by combing the market share of 4 leading producers or by using the Herfindahl-Hirschman Index.
Diversity of Competitors
Another factor that determines the rivalry between the incumbents is the diversity of competitors including the strategies they choose pursue. For example, if the main players in the market have chosen aggressive growth strategies the competition will become more intense.
27 Porter, Michael E. 1998. Competitive Advantage: Creating and Sustaining Superior Performance. Free Press
28 Porter, Michael E. 1998. Competitive Advantage: Creating and Sustaining Superior Performance. Free Press
32 Product Differentiation
The level of product differentiation is another factor determining the intensity of rivalry within an industry. In case, when rivals tend to offer less differentiated products the more customers will be prone to switching which result in rise of price competition levels. In a sector where the products marketed by competitors are identical, the companies compete only with price. On the contrary, in the industry characterized by high differentiation of offered the price competition may be weak, despite a large number of competing entities.
Excess Capacity and Exit Barriers
According to the Porter five forces model the profitability of the industry is also influenced by relations between demand and capacity. If capacity exceeds the demand the intensity of competition in the industry will rise. If such situation persist the factor
determining the level of competition are exit barriers of a sector. For example when industry characterizes with high amount of fixed assets or strict job protection rights it may be very costly to leave the sector and as a result lower the industry capacity levels. When excess capacity leads towards price competition, the cost structure is the key factor determining the price. If fixed costs are relatively high comparing to variable costs, the firms will continue to serve customers at any price above the variable costs, resulting in significant losses among the players in the industry29. The benefits stemming from scale economy provide additional motivation for enterprises to engage in aggressive price competition with the intention of increase their sales volume.
29 Grant, R. M. 2010. Contemporary Strategy Analysis (7 Ed.). Chichester: John Wiley &
Sons Ltd.
33 2.2.4 The bargaining power of buyers
The bargaining power of customers has a significant impact on the profitability of various business sectors. In a industry where buyers bargaining power is high, they
consumers of goods can negotiate either better price or higher quality of products30.There are two key factors determining the strength of the buyers, their price sensitivity and relative bargaining power. The price sensitivity of buyers will rise if the products purchased have significantly affect their cost structure or the level of differentiation in the industry is low.
One of the main factors affecting the bargaining power of buyers is their size and
concentration in comparison to the suppliers. The bargaining power of a customer rises if there are few buyers purchasing in big quantities. Second factor having a significant impact is buyer‘s information. If buyer is well informed about cost structure of supplier it can negotiate a better price. The last key factor is the ability of buyer to engage in vertical integration. As a result buyers may threaten suppliers that might start manufacturing the product by themselves if their purchasing price is too high.
2.2.5 The bargaining power of suppliers
In case when suppliers have high bargaining power they can choose to raise the prices or reduce the quality of provided products. High bargaining power of suppliers may lead to decrease of profitability among the companies within a industry if they are unable to transfer the growing costs to the customers by increasing the price of their products. The bargaining
In case when suppliers have high bargaining power they can choose to raise the prices or reduce the quality of provided products. High bargaining power of suppliers may lead to decrease of profitability among the companies within a industry if they are unable to transfer the growing costs to the customers by increasing the price of their products. The bargaining