by

Alexander Niehues
niehues_alexander@bah.com

Justin Zubrod
zubrod_justin@bah.com

Edward Tse
tse_edward@bah.com

Express Opportunities in China

Packaging a Strategy for the International and Domestic Express Delivery Market

Express Opportunities in China

Packaging a Strategy for the International and Domestic Express Delivery Market
Introduction China is on its way to becoming a global trade powerhousewith an economy that is expected to reach a gross domestic product of USD 4.5 trillion within the next decade. Its huge availability of cheap labor has already made China a global manufacturing center, which will continue to strongly drive import and export transportation needs over the coming years. As China strives to further improve the quality of its manufactured products and reliability of delivery, the share of high-value goods as part of the Chinese trade
Exhibit 1
China Foreign Trade Flows (in USD Billions)

flows will rise further increasing the need for express delivery service providers, both domestically and internationally. Because most of Chinas trade flows are focused on the United States, Europe, and the Asia Pacific region, global integrators are well-positioned to capture growing express demand in their worldwide networks. With China increasingly becoming an integrated part of the worldwide manufacturing processes, express delivery services will grow in importance to cover the demand for time-sensitive shipments in global supply chains.

Germany $17 (5%) $18 (4%)

Netherlands $13 (3%)

Russia $9 (2%)

South Korea $42 (11%) $20 (5%) Japan $53 (14%) $43 (10%)
Taiwan $41 (11%)
China Exports
12% 9%
2% 2%
6%

US $29 (8%) $91 (21%)

China Imports
14% 9% 4%
3% 3% 3%

Hong Kong $5 (1%) $68 (16%)

Malaysia $10 (3%)

Computers & Electronic Equipment, Parts Crude Oil Machinery & Motor Vehicles, Parts Plastics in Primary Form Steel & Aluminum Products Iron Ore Other

Apparel & Textiles Computers Electronic Equipment, Parts Steel Products Furniture Other

Legend:

64%

Imports in $USbn Exports in $USbn % value denotes share of total imports or exports respectively

68%

Source: Statistic Department of Customs General Administration of China (for the first half of 2006)

Therefore, it is not surprising that China is the strongest developing market in the Asia-Pacific express and parcels delivery sectorshowing continuous growth close to 30 percent on average per year. At about USD 4.4 billion in 2006, the Chinese express market has already become a major strategic target for global players.

However, despite the investment enthusiasm surrounding exponential growth rates, there are still huge challenges in doing business in China: Over-regulation, fragmentation, a weak transport network, and congestion are holding back the industry. There are many risks for western companies attempting to enter the market, although these did not prevent the major global integrators such as UPS, TNT, DHL, and FedEx from establishing a local presence two decades ago.

Exhibit 2

China Express Delivery Market (2004-2008) in USD Billions and Major Drivers of Growth

Foreign Trade

2001 - 06 CAGR +30% Import/export volume exceeding $1400 bn p.a.

7,4
+28%
Domestic Economic Development

5,8

2,6
Foreign Direct Investment

4,4 2,8 0,9 3,5

1,9 4,8

1,1 2,5
2005

1,4 3,1
2006

8-10% GDP growth in recent years Expect 10% average growth of air cargo traffic next 20 years

3,8

1,9
2004
Domestic Express

2007E

2008E

FDI exceeding $60 bn p.a. Outward FDI by Chinese Enterprises over $7 bn in 2006, growing at 26%

International Express

Market Opening and State Support

Source: Market Research, Boeing, Booz Allen Hamilton Estimate

WTO agreements Closer Economic Partnership Arrangement (CEPA)

When China joined the World Trade Organization (WTO), the country experienced a rapid market liberalization and modernization as well as rising domestic consumption. As a result, the Chinese express market continues to offer huge growth prospects for local and foreign players alike since growth of time-definite deliveries are running at about +40% per year. Tremendous growth in foreign trade and direct investments, strong domestic economic development, and state support in massive infrastructure investments create a market environment that offers tremendous opportunities for both domestic and international express companies.

Despite the large business opportunities, the market is one of the most difficult in which to operate. As it develops further, both domestic and international players need to revisit their strategies to create and maintain sustainable positions that enable them to tap into future expected growth. In light of Chinas explosive growth and the full liberalization of the transport sector, the pressure is now on the express delivery providers to understand new strategic imperatives. They need to anticipate the challenges and obstacles that must be overcome to achieve and secure sustainable, profitable growth in the Chinese international and domestic express market.

A. Chinas International Express Market The Growth Story The beginnings of the market for express delivery services in China date back to the early 1980s, when the Chinese Postal Administration introduced Express Mail Service (EMS) for international deliveries. At that time, the prospects of the Chinese economy opening up to become something resembling a free market, and Chinas eventual accession to the WTO were still far removed from reality. However, the major global integrators such as TNT, UPS, DHL, and FedEx recognized that China presented an opportunity not to be missed. With ever more foreign companies entering China, and the countrys growing awareness for the international exchange of goods and documents, these big four integrators made sure their services were available. All international companies who arrived in the 80s and 90s intwere only able to enter the Chinese market by means of local joint venture partnersforcing international express companies to adopt identical market strategies in the region. All four players chose as their first joint venture partner the state-owned Sinotrans Group, which was the largest player in logistics in China at that time. But in subsequent years, they followed different paths in developing their businesses.

Exhibit 3

Major Events and Growth Periods in China Express 1980 to 2006

Expansion (since 2001) Initiation (1980 - 1988)

Market Establishment after first Express Mail Service offered by China Post Rapid Market Growth following Chinas WTO Accession

from JVs with Sinotrans 1986 enters via agencies

switches JV from Sinotrans to EAS 1995

cancels Sinotrans JV first crossborder flight to Japan 2003

launches domestic service

opens retail stores

starts domestic air service offers direct flights to China

enters via agencies 1981

enters via agencies

buys out starts Hoau DTW aquisition 2006 2005

Domestic EMS launched 2004

enters via Sinotrans JV 1988

switches JV from EAS to forms JV DTW with Sinotrans 1999

Cooperates with Okay Airways 2007

renews Sinotrans JV until 2052 2002

launches domestic service

buys out JV

operates first direct flight of intl cargo airline into China 1996 1980 China Post launches EMS
Source: Literature Search, Company Web Pages

Offers next-day and nextmorning svc 2004

12 / 2001 China joins WTO

12 / 2005 Market opened to WOFEs

Market Strategies of the Big Four

As the first foreign express company in China, DHL signed an agency agreement with Sinotrans in 1981. In 1986, both companies formed the first Chinese international express joint venture (JV), which prevails to this day. In 2003, DHL underlined its strong partnership by purchasing an equity stake of 5 percent in Sinotrans Ltd. Due to its first-in advantage, the DHL/Sinotrans JV now holds the lead position in Chinese international express delivery with about one third of the market. In 2004, DHL was the first of the international integrators to offer a domestic parcel service in China, again via the Sinotrans JV.

FedEx started express operations in China in 1984 on an agency basis and in 1986 entered a JV with Sinotrans, shortly after DHL. After termination of the Sinotrans JV in 1995, FedEx partnered first with smaller EAS International Transportation (now Kerry EAS), and in 1999 switched to the then little known Tianjin Datian W. Group Co., Ltd. (DTW Group). Following these moves to ever-smaller JV partners, at the beginning of 2006, FedEx announced a USD 400 million takeover of DTW Groups express business, including domestic express assets in 89 locations, thus converting its Chinese operations into a wholly owned foreign enterprise (WOFE). FedEx holds an approximately 20 percent market share of the international express delivery market.

In 1988, UPS followed the same approach as DHL and FedEx and used Sinotrans as a delivery agent to gain access to the Chinese express market. This was followed by a joint venture agreement in 1996 and equity investments in Sinotrans in 2003. Because of competitive conflicts with the DHL-Sinotrans JV, UPS exited the cooperative agreement in 2004. It effectively bought out the existing customer contacts and 23 stations in major cities for USD 100 million in an agreement phased until the end of 2005. Thus, UPS has established its own network in China, which currently serves about 19 percent of the international express market.

TNT Express also entered the Chinese market in 1988, by means of a JV with Sinotrans that lasted until 2003. Subsequently, TNT took over about 90 percent of the employees and entered into a new JV with a very small partner, Machplus (founded in 1999 and with 800 staff at the time). The company built a network of 25 owned and 50 franchised locations serving about 600 cities across the country. Since 2005, this company also offers domestic services. TNT is currently the smallest player of the big four with about a 7 to 8 percent market share of the Chinese international express market.

Exhibit 4

China International Express Market Shares (1995 vs. 2006)

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

2%

6% 7-8% 18-20%

Other

19-21% 97% 19-21%

30-34% 1% 1995 2006

Source: DHL, Morgan Stanley, Press search, China Economic Review June, 2006; Press Search; BAH analysis

Over time, the 'big four global integrators' have captured between about 80 percent of Chinas international express market, absorbing the largest part of the immense market growth into their networks. The incumbent state-owned EMS of China Post, which held 97 percent of the market in 1995, comparatively stagnated at low single-digit growth rates. One reason is that the early presence of all large integrators ensured they were in place when their existing multi-national corporation customers (MNC) entered China. The key factor, however, is the non-competitive international product offering of EMS. China Post got a late start, in 2003, in operating its first few international flights. It largely relies on the Universal Postal Union network of national post operators for international delivery. Delivery times in its existing network are dependent on the individual postal operators handling capabilities and are far removed from the next-day time-definite guarantees the large integrators offer for an increasing number of destinations. Competitive Landscape As the former incumbent, EMS is working hard to catch up with time-definite delivery services. In May 2004, EMS set up a service with Singapore Post and Japan Post that guarantees time-definite express delivery between China, Singapore, and Japan. EMS also part-

nered with the TNT Group in offering a China Express international delivery product that serves international destinations via the TNT network, providing express delivery to major European centers. In addition, China Post launched a speeded up All Night Flight delivery program, which guarantees that mail reaches recipients in Chinas biggest cities by 10 a.m. the following day. Competition in the China express industry remains intense, with operators snapping up opportunities in an effort to stay ahead of the competition. For example, FedEx invested USD 150 million into a new hub at the Guangzhou Baiyun International Airport in Southern China, the largest air cargo hub in Asia Pacific. In 2007, UPS will establish an international air hub at Pudong International Airport and plans to open more than 20 new facilities in major Chinese cities during the next two years. TNT has put two new B747-400ERF 100-ton cargo planes into operation that will go into daily service between Europe and China, massively increasing uplift capacity. Overall, the big four international players are well established in the China international express market and have divided up the market among themselves. Each one offers comprehensive service levels at competitive prices and has partially complementary competen-

cies in serving the European and U.S. markets. None of these players have a major competitive advantage nor does EMS have any options for breaking out of its primarily regional role. The key for any further market developments, therefore, is the way in which companies operate within China and if and how they set up their domestic delivery networks. New Strategic Opportunities With Chinas announcement that it would open up the ground transportation market to WOFEs, new strategic opportunities arose. DHL remains the only international express integrator that is still operating in a strong JV relationship with Sinotranspresumably locked in by mutual long-term commitments and managements belief that the close governmental ties offered by Sinotrans provide a competitive edge. Despite inherent though smaller conflicts of interest between Sinotrans Freight Forwarding and 3PL Business with DHL Exel Supply Chain Solutions acting as competitors in some segmentsDHL Express sticks to the joint venture. Annual growth figures of up to 45 percent for express volume and revenue seem to prove that DHLs strategy is the right one.

The other integrators follow the route of higher independence in the Chinese express market, to be quicker in their decision making, gain more control over their operations, and avoid internal cultural conflicts. FedEx and TNT have followed similar approaches after deciding the Sinotrans JV did not fulfill their strategic purposes; both companies chose much smaller JV partners. FedEx cooperated with smaller partners, EAS and DTW, They both offered significant benefit to FedExs operations at the time of JV formation but were small enough to avoid dependence. FedExs final move was the complete takeover of DTWs express division in 2006. TNT joined with Machplus, a company so small that TNT had great control over the Chinese assets from the beginning. Since 2003, TNT has effectively operated independently. UPS remained with the Sinotrans JV until December 2004, when it signed a USD 100 million agreement to take direct control of Sinotrans operations in 23 Chinese cities. The three integrators now operating independently have taken a big step. Although they have gained significant knowledge of the local market and culture through their long phase of cooperation, they are faced with challenges such as more limited network coverage. This has opened a new competitive battlefield the Chinese domestic express delivery market

Exhibit 5

China International Express Market Shares (1995 vs. 2006)

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

3%

97%

40%

1995

2006

Source: China Economic Review June, 2006; Lit Search; Booz Allen Estimates

B. Chinas Domestic Express Market Similar to the international express market, China Post used to be the monopoly in the domestic express delivery market a decade ago, but has been losing significant market share since then (see Exhibit 5). Although China Post is still the strongest player, it continuously loses ground to fast growing domestic competitors. With the final opening of the express market in 2005, China Posts remaining safe income stream is the state-guaranteed monopoly on delivery of personal mail letters, since now all operators are allowed to deliver business letters. China Post is trying to lobby for new regulation, for example, to ban all express companies in China (other than EMS) from delivering goods that weigh less than 350 grams, but these efforts face pressure from competitors as well as the State Council. Over the last years, with the rapid growth of China express, many new operators came into play in the domestic market. Among the thousands of small to medium-sized companies, the vast majority are local truckers who operate at very low prices and varying (mostly low standard) service levels in the fragmented geographical and regulatory landscape of Chinese logistics operations. The strong protectionism of local authorities, especially with regard to road transport, put up significant barriers to large expansion strategies. Some local operators, however, have found ways to expand profitably in the last decades double-digit growth environment. Nonetheless, none of the new emerging local operators captured more than 10 percent of the market, leaving all the players except China Post in very fragmented positions.

Exhibit 6

State-owned and Private Players in the China Domestic Express Segment

Company

Type
State-owned Infrastructure

Express Services
Domestic express International transportation and logistics Domestic express 8/12/24/36/48-hr. service Domestic express 12/24/48-hr. 3/4/5-day service Value added services Internatl express Domestic express 24/48-hr. service Internatl express Domestic express in Zheijang and Jiangsu

Network
736 service hubs in 275 Chinese cities Door-to-door service network covers more than 380 Chinese cities 287 cities 900 domestic air routes between 129 airports >2.000 cities and districts, 40 branches 1.200 vehicles, 14 rented airplanes 8.000 employees

Notes
Largest competitor of EMS, more than USD 150 million revenue Expanding air and road network Founded 1996 by Civil Aviation Authority under participation of all major domestic airlines Largest private express company in China, founded 1994 in Beijing ~USD 100 million revenue in 2005, rapidly growing Founded 1994, with headquarters in Shanghai Handles ~200.000 parcels/day Founded in Shanghai Handles ~200.000 parcels/day Founded 1993 in Guangdong EAS is a former JV partner of FedEx, taken over by international Kerry Group in 2005 More than USD 100 million revenue; generally 3PL but references to large share of Express Former FedEx JV partner, all express business (even non-JV domestic) bought out by FedEx early 2006 Largest private road network in China In negotiation with TNT for takeover to be completed by mid 2007 (for 135 Mio. USD)

China Rail Express State-owned Infrastructure Nation-wide Express

China Air Express

ZJS Express Nation-wide Express Regional Road Express Regional Road Express International Logistics Group, 3PL Integrated Logistics, 3PL CNEX/Jiaji Integrated Logistics, 3PL DTW Group Freight + Package Road Transport Hoau Group
Source: Literature Search, Company Web Pages

TTK Express STO Express SF Express

500 cities 11.000 employees > 400 delivery points > 2.000 vehicles 10.000 employees

Kerry EAS

> 100 cities Domestic express in Guangdong, plus 20 provinces Hong Kong Domestic 12/24/36/ > 1.100 cities, 48/72-hr. service 100 branches and internatl express Express delivery 1.000 service points > 3.000 trucks, of which 1.200 are long-haul 10.000 employees 144 stations in JV with FedEx 89 domestic locations previously not in JV 1.100 depots 56 hubs 3.000 trucks 12.000 employees

Domestic express International express in FedEx JV Package delivery

Market Strategies of Selected Domestic Players Established in 1993, the China Railway Express (CRE) rapidly expanded its service to more than 300 cities in China. In 2003, CRE invested in its own trucks and increased the number of sorting and logistics facilities by an additional 12 cities from the original single one in Beijing. In 2004, CRE gained access to more than 60 domestic air routes through airline partnerships, and thus is able to provide faster service across the country. Currently, CRE is serving more than 380 cities. With an express revenue of more than 150 million USD and a domestic market share of approximately 5 to 10 percent, CRE is the second largest provider of domestic express services in China after EMS. Despite having some limited flexibility in pricing and market approach because of direct control by the Chinese Ministry of Railroads (MOR), CRE has established itself as a premium provider and is investing heavily in infrastructure and IT to ensure growth and reliable delivery. China Air Express is another stateowned provider of express services. It was founded in 1996 under direct control of the Civil Aviation Administration of China and has access to the majority of Chinese airlines and airports. It was one of the first companies in China to offer time-definite delivery via its network of more than 900 domestic air routes between 129 airports. The company is covering about 280 cities and starting to expand local road transport distribution centers. Of the private companies, the largest pure-breed express operator is ZJS Zhai Ji Song (ZJS) Express. Founded in 1994 in Beijing, ZJS offers a number of flexible express services with delivery times between 12 hours and 5 days. Its overall network covers 2.000 districts and cities and around 40 branch companies. ZJS is also offering a number of value-added services such as insurance, payment collection, and packing and storage service. From a backbone of airline-connected major centers, the network has been developed down to smaller municipalities covering more than 1,000 cities. Revenue has reached about USD 100 million in 2005, with year-on-year growth peaking at about 70 percent in 2003/2004. According to the ambitious company leader, Chen Ping, We aim to enter into the stock market, name our own flights, board on the Top 500 companies list, and become the most famous domestic express company in China. The second private express company that operates across China is Tian Tian Kuai (TTK) Express. Based in Shanghai, its network covers about 500 cities and reaches remote areas such as Inner Mongolia or Tibet, but the main focus is on the Zhujiang River Delta, the Yangtse River Delta, and offshore Bohai Gulf regions. In 2004, TTKs revenue was about 10 percent lower than that of ZJS. Like ZJS, TTK also offers an option for international express delivery. It is interesting to note that these two companies have the most professional and complete English-language web presence of all Chinese operators reviewed in this paper. Of the more regionally road-based express companies, examples of sizable players are SF Express and STO Express. They offer a very dense transportation network in their region at competitive prices, without having the far-reaching aviation interface that allows them to offer nationwide services. Their competitive advantage is based on their local connections. These companies are quite sizable; STO Express, for example, delivers 200.000 pieces per day, which is on the same order of magnitude as TTK. However, as their network is exclusively road based, expanding to much larger regions would require changing the mode of operation; thus in their current form, these enterprises are limited to the growth of their regional markets.

In addition to exclusive express delivery providers, there are numerous integrated logistics firms that also provide domestic time-definite services. The most prominent of these are shown in Exhibit 6. They mostly focus on 3PL services and are generally not considered as core competitors in the Chinese express market. Of special interest are the DTW Group and the Hoau Group, which are being bought by FedEx and TNT, respectively, to further strengthen their footprint in the Chinese transport market.

Building the Domestic Express Business in China At the beginning of 2006, immediately after China has opened the market following WTO accession requirements, all four large international integrators are poised to expand in the Chinese domestic market with full steam. Every one of them has announced that they plan to actively participate in the massive growth that is expected for years to come. They have set up legal structures and built or bought a beachhead into the market, but none of them has any sizable market share yet.
Exhibit 7

opening for WOFEs, was the first international integrator to enter into the domestic express market in 2004 - offering some 70 domestic destinations, reaching already about 95% of the domestic population. This move enabled DHL to fully leverage its existing China network to better use the less-than-truckload (LTL) pick-up and delivery fleets and increased its participation in domestic trade. Nonetheless, some hurdles remain:

Overview of the Big Four International Express Players Strategic Footprint in China

Network Coverage

318 cities, 56 outlets, 163 stations

> 220 cities, to increase by 100 in the next 5 years 1984, JV with Sinotrans in 1986 WOFE since Jan. 2006 > 6.000

330 cities, covered by 75 facilities 1988, JV with Sinotrans in 1996 WOFE since Jan. 2006 > 3.500 by the end of 2006 6.500 in APAC total

>600 cities, 25 owned + 50 franchise facilities 1988 via JV with Sinotrans Effectively WOFE since 2003 > 3.000 (Feb 2007)

Year of Market Entry 1981, JV with Sinotrans in 1986 Type of Presence Staff Sinotrans JV since 1986 ~ 9.200

Strategic Announcements

Expansion of Air Freight In Jan, 2006, FedEx business with 17 domestic bought out DTW for destinations USD 400m Raising stake in Air Hong Kong to 40%, Cathay Pacific holding 60% Outlets to increase from 50 to over 70 USD 200m+ infrastructure investments, expanding Pudong, Guangzhou and Hong Kong hubs May move its AP express hub from the Philippines to Guangzhou in Southern China

Opened first two express retail centers in September 2006 Moved its China HQ from Hong Kong to Shanghai in July 2003 Departed Sinotrans JV for USD 100 million Investing USD 500m into new hub at Shanghais Pudong airport

Has set up an effective franchising system since 2003 Expansion of cooperation with China Southern Airlines Hoau Acquisition underway, freight/parcel company serving over 1.100 locations

Key Facts

DHL has the longest history in China and continues to build its success on the proven Sinotrans joint venture.

China is the only country for which FedEx has established a separate headquarter, showing its importance as a market.

Brown Initiative aims to have only direct operations; no JV or agents in the future to ensure 100% UPS brand.

China is the focus for TNT Express at the moment: We aim to establish our second home market in China.

Source: Bear Stearns, Reuters, FT, Morgan Stanley, Company Web Pages, Booz Allen Estimate (based as of end 2006)

The players that have so successfully dominated Chinas international express market with their product offerings, have chosen quite different ways to approach the domestic market. DHL, building on the long-standing joint venture relationship with Sinotrans and thus not waiting for the market

DHLs prices are currently about 25 percent higher than those of China Post. With its acquisition of 17 domestic airfreight licences in 2007 (e.g. operating out of major cities such as Shanghai, Beijing, Dalian and Tianjin), DHL is now the only one of the big four that offers a domestic airfreight express services in China. Going forward, DHL plans to invest about $215 million in express

10

centers, new branches, express logistics centers and strategic spare-parts centers. FedEx is in the process of fully acquiring the express operations of its present joint venture partner DTW. This process will be concluded in the first half of 2007. In addition to its current JV operations, FedEx will have full control of DTWs domestic express network in 89 cities, which DTW started to build in 2002. FedEx plans to open up another 32 branch offices in China reaching a total of 58 establishments that covers a network of 300 cities and provinces by end of 2007. UPS was the first western company to announce the change to wholly owned operations. The buy-out of the Sinotrans JV in early 2005 gave UPS full control over its operations in China, but did not include any domestic business. In July 2005, the company announced it would offer domestic next-day service between 23 metropolitan areas, which according to UPS generate about 80 percent of Chinas international trade. In August 2006, the company opened two retail stores in Shanghais business district, in a move to position its product offerings with professional services industries. Currently, UPS has 4.000 employees in China. Being the express & logistics sponsor for the Bejing Organizing Committee for the Olympic Games is expected further bolster brand identity in the region. TNT is the most ambitious in setting targets for China, with its CEO, Peter Bakker, stating in 2005 that TNTs aim was becoming market leader in the Chinese domestic express market. To this end, TNT has, in addition to its owned stations, opened a franchising system to quickly expand its branch network. TNT claims its 25 owned and 50 franchised facilities cover more than 600 cities, which is a higher number than quoted by any other foreign operator. TNTs second strategic move is the takeover of Hoau Group, which is assumed to operate the largest private road transportation network in China. If the negotiations succeed, TNT will control a massive infrastructure of 3,000 trucks and almost 1,200 depots across China and plans to differentiate itself from the other competitors by operating a comprehensive road transportation network across Southeast Asia. In the long-term, TNT expects to build up 1.100 depots in China.

Different Routes to Capture Domestic Growth Of the big four integrators strategies, the most obvious differentiating factor is the way they expand their business: Acquisitions (FedEx and TNT) Organic growth (DHLs Sinotrans JV and UPS, partially) For companies entering a foreign market, acquisitions are often a natural route for quickly gaining market share. In China, however, mergers and acquisitions (M&A) have little history, because Chinese culture values blood authentic relationships in businessonly organically grown branches are considered as really belonging to a company. In the case of the FedEx and TNT takeovers, the dangers seem manageable because both companies have already established a strong presence and local management in China. The FedEx acquisition of DTWs express business can be seen as a natural expansion of the previously existing joint venture, and FedEx has taken care of building up its local workforce: More than 80 percent of the FedEx-DTW JV managers are Chinese citizens, and FedEx was ranked by Hewitt Associates in 2005 as among the Top Ten Best Companies To Work For in China. TNTs acquisition plans follow a different strategy than that of FedEx. Hoau is not a direct competitor in the express market because it is mainly a trucking company and has no previous immediate relationship to its new owner. Thus, TNT will focus on maintaining the key performance indicators (KPI) of the infrastructure and transportation service Hoau can provide its express business. Chinas administrative structure could present an obstacle: as local protectionism still prevails in many administrations, a foreign-owned company could suddenly face difficulties such as excessively long handling times for crossing districts. Because this is fundamentally the same issue facing a company from a different city or province, Hoau, with its existing nationwide network will have developed strategies and contacts to operate in this environment. In general, an acquisition strategy in China will be challenging. Because of the high market fragmentation there are few known targets and limited data available to conduct a detailed due diligence. Thus, only

11

small acquisitions by service and/or geography are possible, which result in incremental growth instead of a large leap forward. Rolling up and integrating regional express players into an existing network and organization will be very difficult. Political interference is another hurdle to overcome because the Chinese government will protect state-owned enterprises and intellectual property. When considering growth via acquisitions, an international player needs to consider six major evaluation criteria relevant to a successful integration:

1. Potential to fully acquire the target or at least obtain a majority stake 2. Brand reputation and awareness in China 3. Geographic attractiveness (domestic versus international) 4. Financial attractiveness/soundness of operations and customer base 5. Product/service mix, vertical industry coverage 6. Target relationship with local government officials

Exhibit 8

Hurdles to Achieve Growth in China Via Acquisitions

Political Interference
Government protects

Intellectual Property Protection

Risk of know-how leakage Need to retain local

state-owned companies

employees

Limited Resources
Understanding of regional

Limited Players Information

Limited reliable data Unique accounting

Fragmented Market
All potential companies

conditions only by locals

<5% market share

Unfulfilled staffing needs

methods in China

Only regional coverage

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Critical Success Factors in China Domestic Express a. Geographical Concentration The three costal regions, Bo Hai Bay, the Yangtze River Delta, and the Pearl River Delta, have 30 percent of the total population and represent about half of Chinas gross domestic product (GDP). These areas attract 75 percent of foreign direct investment and 84 percent of all international trade volumes. These are also the areas where the big four have focused their operations, generating the majority of their express revenue along the coastal regions. b. Price-Service Competitiveness What will be the right strategy for success in this highly competitive and fragmented environment? The success of a domestically grown company like ZJS shows it is possible to build a competitive nationwide infrastructure. But the ZJS example also shows the difficulties of surviving the competition in China. The company generally handles consignments in the range of 5 to 100 kg, with a typical size of 30 kg. A price comparison shows that CRE is offering 24-hour service for 5 kg and 40 kg for a lower price than ZJSs 48-hour product. In

Exhibit 9

Geographical Areas of Growth for High-Value Express Delivery Services

Bo Hai Bay Population GDP Foreign Investment Intl Trade Yangtze River Delta Population GDP Foreign Investment Intl Trade Pearl River Delta Population GDP Foreign Investment Intl Trade
Source: Bear China Statistical Year Book; Booz Allen Hamilton Analysis

12% 18% 21% 19%

11% 20% 35% 30%

6% 10% 21% 35%

Over the next years, the demand in the costal regions for express delivery of high-value products will continue to outgrow other areas in China. Since transportation networks are well established already, economies of scale will drive down operating costs and offer competitive prices that are necessary to be successful in the domestic express market and provide a strong footprint to expand to the (less developed) western regions of China.

mid-2005, the vice president of ZJS, Xiong Xingming, said that in the face of rising fuel prices, increasing logistics costs, and cutthroat competition, margins had dropped down to 5 percent from the previous 10 percent. Although FedEx and UPS currently do not offer domestic express services between Beijing and Shanghai, DHLs domestic delivery prices seem to be significantly higher than other players express services (see Exhibit 10).

13

The only way to justify higher prices is service and quality levels. The Chinese logistics market can be characterized with three Ls: Low Skills, Low Levels, and Low Prices. This is typically true of operations across most of the more than two million small local trucking companies in China, where about 80 percent of trucks have no solid body but nylon covered beds. Overloading is common practice, and trucking and warehousing workers often carelessly handle packages, leading to
Exhibit 10

c. Staff Resources and Expertise Another key factor for high service quality is attracting and maintaining a skilled and loyal labor force. This is even more important in China than in other countries, because the market is growing more rapidly than education can provide skilled professionals: China will lack about one million logistics professionals by 2010 and growth targets of the big four require about a ten-fold addition of new resources over the next two to three

Examples of Domestic Inter-city Express Delivery Prices of Major Players in China Price for a single package from Beijing to Shanghai (USD Exchange Rate of September 07, 2006) 24 hrs Delivery 5 kg 27 48 hrs Delivery 5 kg 40

0.5 kg DHL FedEx UPS TNT EMS CRE CAE ZJS TTK STO SF KEAS DTW 2 kg up (14.40)

40 kg 170

0.5 kg 40

40 kg 78

5,30 6,30 Crgo, min 5 kg 45 18 10

11,70 11,30 11,30 54 18 19 No Service 39 10

currently no Domestic service currently no Domestic service 8,80 55 2,50 25 161 42 98 4,40 14 1,30

8,80 9,30 No Service (only 3 days) 13 14 5,30 7,60 14 10

62 101 35 41 52 35 58

28 4,10

No Service (min 3 days) 2,50 121 3,10 58 4,10

Source: Booz Allen Hamilton Market Research; based on Full-Rate Card Quotes

high damage ratios. In a 2005 survey among 3PLs in China, Quality of service, Data tracking, and Cargo security were among the most frequently named challenges (topped only by Government regulations). For the express business, timeliness of delivery is of similar importance to physical integrity of shipments.. In this area, the market leader EMS is behind many of its private competitors, having pushed the on-time delivery of domestic EMS mail items to more than 90 percent. The Chinese market participants have recognized the importance of offering high-quality services. In addition to verbal commitments and money-back guarantees, many companies heavily invest in IT infrastructure to ensure the smooth flow of goods. For example, CRE is featured by Intel as a showcase customer for wireless mobile applications in tracking shipments. In this area, the international players certainly have some expertise to bring into the market, but the large Chinese companies are already quite advanced in optimizing their process flows.

years. Consequently, numerous companies follow a strategy of up-skilling and retaining staff. For example, FedEx is offering each employee up to USD 2,500 in tuition reimbursements for training and is following a strategy of promoting internallymore than 90 percent of management positions in Asia are filled by people who began their careers in non-management positions. TNT has built a TNT China University in cooperation with a Shanghai management school and is one of very few foreign enterprises offering a comprehensive internship program. In TNTs franchising system, the members are enrolled into a specific internal training program to build their skill base. This type of a globalbackground education cannot be matched by the much smaller Chinese companies. It may indeed be a key attraction for employees in a country where, according to a recent survey, more than half of the students leave university with the feeling of never having learned anything practical.

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d. Local Network and Licenses High complexity for the players in the Chinese parcel delivery market arises from the complicated and often inefficient legal procedures, which are strongly driven by local administrations. For road transport, which is crucial for the domestic business, legislation exists at the national, provincial, and local level; local protectionism often leads to difficulties for non-local vehicles and ranges from high tolls and lengthy registration procedures for entering a city to close supervision and heavy-handed fining for minor breaches of regulation.
Exhibit 11
Required Enterprise Licenses and Certificates for International and Domestic Air Express

road transport network may prove to be a valuable asset in the same respect. e. Vertical Industry Focus To achieve profitable growth in the China market, express delivery players need to concentrate their efforts on sizable industry verticals that offer a good economic delivery model in terms of both pick-up and delivery costs, which are influenced by delivery times and consignment weight. Whereas front-door, low-

Enterprise Licenses and Certificates Enterprise Establishment License Enterprise Legal Person Business License Int. Freight Forwarding Enterprise Certificate of Approval Postal Entrustment Class 1 Cargo Sales Agent Air Express Permit Customs Declaration Agent Certificate Customs Bonded Warehouse Certificate Customs Supervised Export Warehouse Certificate Import Export Quarantine Agent Import/Export Express Operator Quarantine Inspection Declaration of Import/Export Express Operator
Source: Booz Allen Hamilton Market Research

International
X X X X X

Domestic
X X

X X

X
X X X X

Some downtown areas are closed for trucks between 7 a.m. and 7 p.m. Another critical success factor to ensure future growth is to obtain the relevant operating licenses to be able to offer international and domestic express services. In addition to legal difficulties, the security situation in some areas of the country mandates escorting trucks to avoid loss of goods and vehicles, which drives up costs, especially for high-value express delivery. In this type of environment, it is essential to have a deep understanding of the various factors and a broad network of local connections. DHL enjoy a certain advantage in this area, with its strong JV partner Sinotrans and 18,000 employees. If TNT does a good job of managing the Hoau integration, that companys wide-spread

weight parcels offer a high degree of automation (e.g., electronics, computing, and retail industry) and thus keep operations costs to a minimum, there might also be opportunities in the more heavy-weight, back-door business (e.g., automotive, machinery, and equipment industry) because delivery density tends to be higher due to consolidated consignment shipments. Looking at the growth figures across some selected industries that require time-definite express deliveries, most sectors in China show above GDP growth, especially the electronics and computing and the automotive and transportation industries. These fast growing industry verticals offer an attractive segment to further expand local operations as customers require nationwide, expedited transportation services at high quality,

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Exhibit 12

Comparison of Economic Express Delivery Models Across Different Industry Verticals

10% later
Metal Products Chemical Wholesale Retail

5% Delivery Time 1)

Pharma / Health Care Automotive Transport

Building & Construction Electronics & Computing

0%
Professional Services

Food, Beverages, & Tobacco Public Sector

Paper, Publishing & Printing

-5% earlier

Textile

Other Services Machinery & Equipment

Financial Services

-10% -30% lower

-20%

-10%

0%

10%

20%

30% higher

40%

Average Weight per Consignment

1) Difference in % vs. weighted average across all industries Source: Booz Allen Hamilton Market Research

but also rely on international coverage (e.g., for overseas on-time deliveries). Players with additional supply chain logistics servicelike the big fourshould be able to differentiate themselves and move out of the lowcost priced market by focusing on time sensitive verticals that explicitly ask for value added services such as after-market logistics capabilities, inventory management, and other 3PL solutions.

and multinational customer bases to divide the market mostly among themselves. The only significant Chinese competitor is China Posts EMS service. Similar to postal operators in other countries, EMS offers a product that cannot directly compete with the comprehensive services of the integrators, and therefore is
Exhibit 13
Estimated Growth of Selected Industry Verticals in China

Conclusion Looking at the development of Chinas GDP and its foreign and domestic trade volumes, it is clear that the country currently offers the major growth market for express delivery services worldwide. Such growth will probably only be matched by a similar evolution in India. This has been clearly recognized by the big four global players in the industry, namely DHL, FedEx, UPS, and TNT. Consequently, all of them are pursuing aggressive growth strategies in the region. In the international market, the global players have been quite successful in using their existing networks

Electronics & Computing

13-14%

Automotive & Transport

12-13%

Textiles & Apparel

9-10%

Consumer Products

8-9%

China GDP
Source: WTO, Global Insight, China Statistics Yearbook: Booz Allen Hamilton Estimates

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viewed as filling a limited market niche in Chinas international express segment. Looking forward, we do not expect any major shifts driven by developments within the market; changes will primarily result from global strategies or from the domestic business the integrators builda strong domestic market position may lead to synergies for their customers, but overall the links between international and domestic express operations are rather small. In the domestic market, the rapid growth (which has eroded the previous postal monopoly) has so far been captured by a multitude of fragmented small players, some of which have shown the potential to build decent market positions. The global integrators have entered this market recently and are now in a similar position to many of the much smaller local players. Important factors in the domestic express market are price competitiveness, service quality, staff expertise, and local connections. Along those dimensions, it should be noted that a number of strategic initiatives may in the end decide ultimate market success. Provided below are some examples of these initiatives: Brand Marketing: UPS is currently showing the most consistent approach. Following the so-called Brown Initiative, the company is committed to operating only on fully owned assets, explicitly excluding any joint venture or agent operations to ensure a clear corporate identity is carried in each customer contact. At the same time, UPS is carrying its brand to the public in its newly opened retail stores and via sponsorship of the 2008 Beijing Olympics, for which UPS is the designated logistics partner Service Differentiation: Targeting very specific customer segments is one way to maintain profit margins in the low-price Chinese market. An example for this is TNTs Clinical Express product for the clinical trial diagnostics market. Even though there are many labs in China, for special examinations valuable specimens often have to be transported to diagnostic centers or even overseas to such places as the United Kingdom. This kind of transport was often carried out by lab staff personally carrying the samples on passenger flights. With Clinical Express, TNT takes care of properly handling the sample, which can be quite lucrative a package to Europe that would normally

have a USD 400 value could end up costing USD 2000! Cooperation: Many cooperation models have been tried in the Chinese market. In 1999, for example, FedEx partnered with Kodak photo stores to serve as pickup and delivery points. These stores form a nationwide network of more than 8,000 locations across China,. TNT has a strategic partnership with EMS, employing the nationwide network of postmen to deliver its parcels, as well as a code sharing agreement with China Southern airlines. Very little information about these agreements is available after the initial announcements, leading to the assumption that they were not successful. The reasons for this are unclear because cooperation, especially between a local player with a strong last-mile transportation infrastructure and a global player with the international network, seems to be quite natural, although it is possible that the cooperation model is simply overshadowed by the next option. Selected Acquisitions: All private players in the Chinese logistics market are very small compared to the global integrators. Instead of cooperating to deliver a service, it is an even more straightforward choice to directly buy the smaller partner, as UPS and FedEx did when they acquired their JV partners or TNT did in its takeover of Hoau group, which as a local infrastructure provider ideally offers the last mile component to TNTs express product. While some of the acquisitions may not add significant operational assets and capabilities, they can help build the customer base and add volume into the acquisitions network. At the moment, no single operator has shown a significant competitive advantage that puts the company at the top of the pack. Success is and will be defined by a multitude of key success factors that are required to tap into the growing domestic express market. It might be possible that some local players like CRE and ZJS, with their greater experience in Chinese operations, will grow their positions to be dominant in the market. On the other hand, the foreign international integrators with their global reach and financial power may still decide the race in their favor. The opportunity is there now it needs to be captured!

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Booz Allen Hamilton has been at the forefront of management consulting for businesses and governments for more than 90 years. Integrating the full range of consulting capabilities, Booz Allen is the one firm that helps clients solve their toughest problems, working by their side to help them achieve their missions. Booz Allen is committed to delivering results that endure. With 18,000 employees on six continents, the firm generates annual sales that exceed $3.7 billion. Booz Allen has been recognized as a consultant and an employer of choice. In 2005 and in 2006, Fortune magazine named Booz Allen one of The 100 Best Companies to Work For, and for the past seven years, Working Mother has ranked the firm among its 100 Best Companies for Working Mothers. To learn more about the firm, visit the Booz Allen Web site at www.boozallen.com. To learn more about the best ideas in business, visit www.strategy-business. com, the Web site for strategy+business, a quarterly journal sponsored by Booz Allen.

For more information on Booz Allens capabilities in Express Services, Freight, Postal and Logistics, and Transportation Know-how, please see our Web site at www.boozallen.com or contact one of our local offices.

Justin Zubrod is a vice president in Booz Allens Washington office. He leads Booz Allens U.S. Postal, Freight & Logistics practice and has conducted a multitude of assignments for international transportation clients. Edward Tse is the managing partner for Booz Allens Greater China practice. The partner-in-charge of the first authorized office in mainland China among all international strategy consulting firms in the early 1990s, Dr. Tse has consulted to hundreds of foreign and Chinese clients, including transport and logistics providers.

Alexander Niehues is a vice president in Booz Allens Munich office in Germany. He leads the European Postal, Freight & Logistics practice and has led major assignments at the worlds leading postal, express, and contract logistics operators.

China Dr. Edward Tse Booz Allen Hamilton (China) LLC Suite 2511, One Corporate Ave 222 Hu Bin Road Shanghai 200021 Phone: +86-21-6340-6633 tse_edward@bah.com Europe Alexander Niehues Booz Allen Hamilton GmbH Lenbachplatz 3 Munich 80333 Germany Phone: +49-89-54525-0 niehues_alexander@bah.com United States Justin Zubrod Booz Allen Hamilton Inc. Hamilton Building 8283 Greensboro Drive McLean, VA 22102 United States Phone: +1-703-902-5000 zubrod_justin@bah.com

Japan Akira Uchida Booz Allen Hamilton (Japan) Inc. Shiroyama Hills 18F 4-3-1 Toranomon, Minato-ku Tokyo 105-6018 Japan Phone: +81-3-3436-8600 uchida_akira@bah.com Asia-Pacic Simon Gillies Booz Allen Hamilton (Australia) Ltd. Level 7 7 Macquarie Place Sydney NSW 2000 Australia Phone: +61-2-9321-1900 gillies_simon@bah.com Latin America Paolo Pigorini Booz Allen Hamilton do Brazil Praia de Botafogo, 228 sl 512 Rio de Janeiro RJ 22359-900 Brazil Phone: +55-21-2237-8400 pigorini_paolo@bah.com

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