China’s ground logistics are improving quickly, but it’s in the skies that things are really taking off. SBR investigates the underlying factors.
China’s logistics sector is one of the most fragmented in the world: thousands of small, technologically outdated trucking companies jostle for business in an overcrowded market while a legion of motorcycle couriers aim to serve the e-commerce boom and China-heavy international companies like Global Logistics Properties (GLP) take on the world. What is clear of the Middle Kingdom’s logistics sector “on the ground” is that nothing is yet clear, though opportunity abounds for all.
This logistics confusion that characterizes the ground segment of the business quickly changes to rationality when we look to the skies. China’s air cargo sector is the shining jewel of global logistics, with seemingly endless room to grow as the forces that drive development become ever more favorable in this competitive arena. Rising incomes and flourishing middle class consumer lifestyles drive raw demand, rapid urbanization centralizes it, and a lifetime of living in cities with the populations of countries fosters just the right impatience to make rapid delivery a strict requirement.
It is easy to forget amid the bustling competition that air cargo is essentially a transport service. For businesses serving any transport sector, differentiating one’s product is no easy task. Whether we talk about network packets or containers of perishable yoghurt, it is difficult for transport brands to communicate the unique value of their offerings. The core demand of purchasers is that the items be taken from one point to another. Nonetheless, innovative companies in the Chinese cargo logistics sector, particularly in air freight, are making great strides to parallel the success in other sectors, particularly the arena of technology.
As economics students recall, there is a simple model that explains why differentiation in this context is challenging. Mathematician Harold Hotelling’s model from the late 1920s imagines in its simplest form two identically priced ice cream carts deciding where to set up on a beach occupied by people who prefer not to walk much. In equilibrium, the carts will set up right beside each other in the center of the boardwalk. At any other position, one cart could move closer to the other to increase revenue, as the stretch of beach on the side they are closest to is captive and the stretch between the two is shared down the middle with people walking to the nearest cart.
Conceptually, location on the beach is the same as marketing any other type of product. Buyers have preferences for particular product attributes, such as not having to walk for ice cream or the latitude of a cargo operator’s regional hub, and there is a limit to the possible products suppliers can offer. What does this mean for logistics profitability? When all the product characteristics are obvious to companies, they end up providing very similar offerings to one another. They all set up in the middle of the metaphorical beach, and have little room to garner market share aside from undercutting each other’s prices. This is not a robust or profitable situation.
In such a dynamic, the way to improve profitability is to come up with novel ideas on which to differentiate services. Such a solution is playing out across the IT and telecom sector, which “delivers” Internet packets and frames around the world to service modern lifestyles and has pushed toward custom service provision. In the past, information communications services have operated more as a basic commodity. Where they could be differentiated, it was in obvious and mundane ways, and they were delivered identically en masse.
The new industry dynamic emphasizes the service nature, coming up with ways to differentiate services that are entirely new and which competitors will not quickly push up against. A near identical trend is beginning to play out in the Chinese cargo sector, particularly in the deep-pocketed consumer air cargo space. Customization and personalization of services for highly segmented demand is delivering products on which to diversify services which competitors have not even conceived of.
This technological differentiation is a boon to the market served by innovative firms and a major profit center for providers who carve out negotiating power with a willingness to serve customer needs. With a winning model figured out, all air cargo firms need is demand to satisfy. This is China’s strength.
In the highest growth sectors, logistics is all about serving the demographic. CKGSB Knowledge, a publication run by the leading Beijing-based business school, puts this in perspective in an interview with an average citizen. Fu Cong, a 33-year-old Shanghai resident, works for an international media company, enjoys photography, the occasional shochu at a “speakeasy-style Japanese bar” and can recommend his favorite scuba diving spots in Thailand. “I’m definitely not middle class. My income isn’t high enough,” Fu says. This is one of a hundred million illustrations of how far China has come in a few short decades, and the high aspirations people have for the future.
Global financial services leader Credit Suisse takes stock of this incredible growth in China’s middle class in their most recent annual Global Wealth Report. China now accounts for 33% of the world’s population with “mid-range wealth”, the band from US$10,000 to US$100,000. This number follows from an enormous expansion in middle class wealth across the nation in recent decades.
“The growth of wealth in emerging markets is most impressive,” notes Credit Suisse CEO Tidjane Thiam. “This growth includes a fivefold rise in China since the beginning of the century.” Even the still-vast rural population that has not yet achieved middle class status is closing in fast, and at an increasing rate. A recent report by the bank finds: “Chinese representation in the poorest 20% of wealth holders has halved, dropping from 14.1% in 2000 to 12.2% in 2008, and more precipitously to 7.5% in 2016”.
This astounding middle class growth pace is made even more relevant by recent history. While mere poverty alleviation in many countries is seen as the critical goal to be achieved, in China it has, is and will continue to be followed in short succession by expansion in the ranks of the middle- and upper-classes.
As if this trend were not evident enough, trendy regression analyses come to the same conclusion, estimating that China will account for about half of the expansion in the global middle class over the next half decade. The air cargo sector has until recently focused on serving China’s unstoppable export machine. “This machine is mostly used for garment (fast fashion), textile, perishables and high tech products exported from China,” according to Ulrich Ogiermann, Qatar Airways Chief Officer Cargo. “The consumer wave is quickly turning this around.”
These endless millions of consumers are anything but reserved with their newfound buying power. With increased purchases comes more demand for logistics and transportation providers. “With the growth of China’s emerging middle/upper income group as well as e-commerce, postal and express services have a bright future,” notes Şeref Kazancı, Turkish Airlines Cargo SVP. While the vast majority of the network for everyday consumer items is land-based, the balance is shifting toward air cargo in upmarket segments. A key driver of this pivot is urbanization.
So, what does this middle class dynamic have to do with the nuts and bolts business of logistics centers and mega-transport planes?
It is undeniable that China, the world’s most populous country, has a lot of people. What is less understood is the population density of the nation as a whole is only 143 people per square kilometer, coming in at the unremarkable 84th highest worldwide. Imagine if China’s population were uniformly distributed across its landmass – the third largest in the world – so this number was actually reflective of the reality on the ground. Air cargo would not be such a hot sector. The number of airports and cargo routes needed to come within rapid delivery distance of a sizable portion of the population would be astronomical and the cost structure impossible to justify.
Luckily for cargo providers, the near opposite situation is playing out. With urban planners in metropolises like Shanghai, Beijing, Guangzhou and Chongqing counting population by the tens of millions, it is clear that centripetal forces are extremely powerful. Flying an international delivery of fresh organic produce to Shanghai, for example, puts it within rapid delivery range of the population of Texas.
“Still, with all the excitement surrounding China’s first tier cities, it is easy to forget the sheer number of other enormous population centers scattered across the country,” remarks Ravishankar Mirle, Emirates Vice President Cargo Commercial Operations for Far East and Australasia. “To illustrate, we are the only international carrier that flies into Yinchuan, Ningxia Autonomous Region.”
The Ningxia economy in the rugged and remote mountains of Western China revolves around primary agricultural products like goji berries. Yet, population dynamics are such that a large enough concentration of demand is able to form for Yinchuan to have its own air cargo route from a major international carrier. Turning a profit from a remote air route like this elsewhere in the world would be an incredible feat, but it is just another day in China. To put things simply, there are a lot of people concentrated in these cities – all of them – and this bodes extremely well for the air cargo industry.
Anyone who has ever eaten at an everyday Chinese eatery has heard the hurried exclamation. Kuai dian! Faster! To laymen observers this takes on an extra air of urgency when spoken with the Northern “erhua” accent, making this phrase more of a “kuai diar”. It is no secret that life in China is perpetually in the fast lane. It is both a cause of and consequence of its rapid expansion. As this attitude spills over to the consumer sphere it becomes a driving air cargo industry dynamic.
Equally rapid is the rising appetite for luxury. This demand is insatiable, and when it cannot be found quickly and easily at home, Chinese consumers go out into the world to seek it. No one is willing to wait for supply to catch up. Shanghai-based partner at Bain & Company Bruno Lannes, who authored a recent report on China’s luxury market, finds the industry struggles to keep up with demand and a revamp is underway. “Our research found that the industry is quickly adapting to challenges and changing expectations in an effort to drive more luxury consumption at home through strategies such as global pricing and a greater focus on fashion.”
A new tech-savvy generation of consumer is flooding the demand side with urgent delivery requests fuelled by fast information access over the web. “Nearly 80% of respondents said they normally get information on luxury brands from the Internet or apps, and a full 60% identified social media channels Weibo and WeChat as their online source for information on luxury goods,” adds Lannes. Supplying – on time – this more informed class of consumer is challenging and brands are spending on average more than one-third of their marketing budget on digital to keep up with
If air cargo is to satisfy this massive time-sensitive demand, they need to turn a profit. With cheaper transportation methods on the ground and more competition in the air, the sector continues to draw business inspiration from elsewhere in the economy. The core idea inspired by the IT sector was novel differentiation of the value proposition. But moving the metaphorical ice cream truck to the parking lot rather than competing on the beach is not going to cut it in the 21st century.
To be successful today, logistics companies will have to recreate the trend in the telecom and communications services provision industries, evolving from an old “dumb pipe” model of information transport to a “smart pipe” one of integrated value-added services.In fact, there is a more universal model underlying the barrage of buzzwords, such as the latest of “intelligentization”. This type of smart revolution requires smart thinking beyond that of abstract theory.
Luckily, the air cargo industry has no shortage of talent to guide it through this profitable remake and work is already afoot to integrate the latest technology into the service line.