Fast Forward: What s next for China s logistics sector kpmg.com/cn

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1 TRANSPORTATION AND LOGISTICS Fast Forward: What s next for China s logistics sector kpmg.com/cn

2 Fast Forward: What s next for China s logistics sector Contents 01 Executive summary 02 Market overview 04 Policies and regulatory environment 06 Competitive

2 2 Fast Forward: What s next for China s logistics sector Contents 01 Executive summary 02 Market overview 04 Policies and regulatory environment 06 Competitive landscape 08 Challenges and opportunities 09 Foreign investment considerations 10 Major logistics hubs in China 12 About KPMG 13 Contact our Transportation and Logistics team

3 Fast Forward: What s next for China s logistics sector 1 Executive summary China s logistics sector has been developing at an extraordinary rate, thanks to the rapid expansion of the country s industrial base and the rise of domestic consumer markets. Essential to the development of China s economy, the logistics sector has received much attention from the government and is attracting substantial foreign and domestic investment. The logistics market has grown annually by around 14 percent over the past five years with the total value added by the logistics industry reaching RMB 2.31 trillion in This constituted a 6.7 percent share of GDP. 1 The efficient distribution of raw materials and finished products is one of the biggest challenges associated with China s rapid economic growth. Expenditure on logistics services, encompassing transport, storage and management functions, reached RMB 6.08 trillion in This expenditure is equivalent to 18 percent of China s Gross Domestic Product (GDP), twice that of many developed countries. It indicates operational efficiency, largely attributed to a fragmented market, continues to be a key challenge facing the industry. The flip side is that there are opportunities for investors to bring about improvements either with consolidation at the market level (through mergers and acquisitions) or with efficiency improvements at the company level. Challenges faced by those seeking to develop the market include regulatory constraints, local barriers to entry and capital strain. The government has taken positive steps, including opening the sector up to foreign logistics companies and introducing institutional reform. The creation of the Ministry of Transport, through the consolidation of a number of government departments in 2008, reflected the determination of the Chinese government to improve administrative efficiency and coordination among departments for policy formulation and execution. With the substantial investments in infrastructure made by the government and further liberalisation of China transport and logistics markets, we are seeing continued improvements among logistics companies operating in China and this is accompanied by some significant consolidation. 1 China Develoment and Reform Commission; China Federation of Logistics and Purchasing; National Bureau of Statistics of China 2 China Develoment and Reform Commission; China Federation of Logistics and Purchasing; National Bureau of Statistics of China

4 2 Fast Forward: What s next for China s logistics sector Market overview The growth of the logistics sector has Table 1: The total value-added by the logistics industry, been fuelled by the rising domestic demand for goods and services and on the supply side by improving transport infrastructure across China. The Year 2005 Total value-added (RMB billion) 1,227 Annual growth 13.9% Share in GDP 6.7% logistics market has seen double-digit annual growth in recent years. The total value-added reached RMB 2.31 trillion ,412 1, % 20.3% 6.7% 6.9% in 2009, representing a 6.7 percent share of GDP , % 6.6% , % 6.7% Given the current stage of China s economic development, the majority of business for logistics companies comes from the movement of industrial products. This accounted for around 90 percent of the value of goods moved in Imported products account for 7.1 percent, a figure that may rise further in the years ahead. Source: China Development and Reform Commission; China Federation of Logistics and Purchasing; National Bureau of Statistics of China Chart 1: Logistics value by category, % 2.5% Industrial products Imported products Others 90.4% Source: China Development and Reform Commission; China Federation of Logistics and Purchasing; National Bureau of Statistics of China

5 Fast Forward: What s next for China s logistics sector 3 As a percentage of GDP, logistics costs are around 18 percent, having dropped slightly from 18.8 percent in 2004 to 18.1 percent in This is still high compared to other developed countries, where logistics costs are typically below 10 percent of GDP. This high figure suggests operational inefficiencies exist throughout the market. Although China s GDP is dependent on industrial sectors to a larger extent than most developed countries, market fragmentation, regulatory constraints and operational challenges have all contributed to relatively high operating costs. The total logistics cost in 2009 was 6.08 trillion. 5 Transportation accounts for the largest component of total logistics costs, with around 55.3 percent (RMB 3.36 trillion). The other components are inventory storage costs (RMB 1.99 trillion) and management costs (RMB 0.73 trillion). Chart 2: Logistics costs as a percent of GDP of select countries, 2007 / % 25% 20% 18.1% 15% 13% 11% 10% 8.2% 4 9.4% 5% 0% EU US Japan India China Vietnam Source: KPMG research based on public and industry news sources Chart 3: Total cost of logistics, % % % 40% 20% % Transportation cost Inventory storage cost Management cost Source: China Development and Reform Commission; China Federation of Logistics and Purchasing; National Bureau of Statistics of China 3 China Federation of Logisitcs and Purchasing 4 Figure in 2007 (Klaus/Kille 2007) 5 China Federation of Logistics and Purchasing

6 4 Fast Forward: What s next for China s logistics sector Policies and regulatory environment The government recognises that certain challenges in the logistics sector are impacting wider economic growth. It has been addressing these through a combination of regulatory measures and government investment in infrastructure to provide more favourable conditions for transport and logistics companies to operate. China s logistics industry has been growing fast since its accession to the World Trade Organization (WTO) in 2001, a landmark in the opening-up of China s markets. The government s eleventh Five Year Plan, running from 2006 to 2010, sets out a number of initiatives to establish the transport and logistics markets in support of the development of China s tertiary industry as well as the growth of the economy as a whole. A major reorganisation at the ministry level was conducted in 2008 to streamline the governance of transport system. The reorganisation involved integrating a number of transportrelated government bodies. The functions of a number of government departments regulating civil aviation, postal services, communications and urban public transportation were consolidated into the newly established Ministry of Transport. Chart 4: Reorganisation of logistics-related administrative institutions in 2008 # Ministry of Communications # Civil Aviation Administration of China # Urban traffic management under the Ministry of Construction Functions merged # Dissolved after restructuring * Newly established Source: Li & Fung Research Centre *Ministry of Transport *State Bureau of Civil Aviation State Post Bureau Put under Chart 5: Administrative institutions for logistics industry in China Central government Local government On 1 October 2009, the new Postal Law took effect. It gives China Post exclusive rights to deliver packages weighing less than 50 grams within cities and to deliver items lighter than 100 grams between cities. National Development and Reform Commission Ministry of Commerce Ministry of Transport State Administration of Taxation Development and Reform Department Transport agencies State Administration for industry & Commerce of the People s Republic of China Commerce agencies Source: Base on a presentation by Ministry of Transport official

Fast Forward: What s next for China s logistics sector 5 In response to the global financial crisis, the government launched a stimulus package of RMB 4 trillion in 2009.

7 Fast Forward: What s next for China s logistics sector 5 In response to the global financial crisis, the government launched a stimulus package of RMB 4 trillion in A majority of the funding was directed to infrastructure development and it provided favorable conditions for the logistics industry to grow. Along with the injection of liquidity into the market, the Chinese government also introduced the Rejuvenating Programme for Logistics Industry in February 2009, which aimed to support the development of the logistics industry for the three year period from 2009 to Attention should be drawn to five industry development goals set by the government which will shape the policy direction in the next few years: To nurture a number of large, internationally competitive logistics enterprises To modernise the logistics service system and provide the use of technologies To increase the share of third party logistics of China s logistics market To increase the scale of the logistics industry and the value it can add To improve operational efficiency of the logistics industry and reduce the ratio of total logistics cost to GDP.

6 Fast Forward: What s next for China s logistics sector Competitive landscape As a result of self-management Table 2: World top 10 fleets by capacity in 2010 and localised operational footprints,

8 6 Fast Forward: What s next for China s logistics sector Competitive landscape As a result of self-management Table 2: World top 10 fleets by capacity in 2010 and localised operational footprints, transportation and logistics operations are highly fragmented. The top 20 Rank Operator TEU Ships transport and logistics companies in 1 APM-Maersk 2,057, China had total revenues of around RMB 330 billion in 2008 about 6 2 Mediterranean Shg Co 1,663, percent of total logistics costs for that 3 CMA CGM Group 1,115, year. 4 APL 595, The competitive landscape is rapidly 5 Evergreen Line 567, changing driven by the following trends: 6 Hapag-Lloyd 544, Foreign players accelerating their 7 COSCO Container L. 501, expansion in the wake of market 8 CSAV Group 498, liberalisation and improvement in infrastructure 9 Hanjin Shipping 448, Domestic players upgrading facilities 10 CSCL 443, and improving their services to compete with foreign entrants Source: AXS-Alphaliner / China Shipbuilding Online Foreign-invested manufacturers looking to improve operating efficiency along their supply chains. Chinese shipping operators are rising quickly with COSCO and CSCL ranking among the world s top 10 fleets in terms of carrying capacity by Twenty- Foot-Unit (TEUs).

Fast Forward: What s next for China s logistics sector 7 Chart 6: China s 20 leading transport and logistics enterprises 2008 (revenue, RMB billion) China Ocean Shipping (Group) 145.

9 Fast Forward: What s next for China s logistics sector 7 Chart 6: China s 20 leading transport and logistics enterprises 2008 (revenue, RMB billion) China Ocean Shipping (Group) China Shipping (Group) China National Foreign Trade Transportation (Group) Corp (Sinotrans) China National Materials Storage and Transportation Corp (CMST) China Railway Express China Railway Container Transport International Cargo Transport Guangdong Nan Yue Logistics Yuan Cheng Group Shandong International Transportation Corporation Maritime (Group) Kerry EAS Logistics Orient International Logistics (Holding) SINOPEC Pipeline Transport & Storage China Petroleum Transportation Group China Merchants Logistics Group Qingdao Haier Logistics Chongqing Port Logistics Group Qingdao Fuxingxiang Logistics China Railway Material DHL-Sinotrans Source: EIU

10 8 Fast Forward: What s next for China s logistics sector Challenges and opportunities China s logistics sector has a number of challenges to overcome in order to improve efficiencies. However, with continued government effort in deregulation, administrative reform and investment in infrastructure, these challenges present opportunities for companies to succeed in this rapidly developing market. The pursuit of logistics efficiency The high ratio of total logistics costs to GDP has drawn the attention of the government and is considered not just an issue of the logistics industry but one of significance to the prospects for overall economic development. 6 The reduction of the ratio has been made a target at all levels of the government and various initiatives have been launched. Further market liberalisation is expected to break down the provincial boundaries and facilitate the development of a national logistics market. The competition brought about as a result of the market liberalisation has prompted further investment. Led by global logistics operators, substantial investment has been injected into the industry establishing regional hubs, upgrading operational systems and training logistics professionals. Domestic logistics operators are, however, catching up quickly with some gaining dominant positions at the regional level. Logistics outsourcing The share of third party logistics in the China s Logistics market is on the rise. It is both a result of government encouragement and the trend towards companies outsourcing their logistics operations to focus on their core business operations and reduce cost. The first batch of third party logistics operators were logistics departments of multinational corporations or sizable domestic enterprises which were spun off. The success of these third party logistics operators demonstrated the viability and potential of the business model. As the benefits of this approach become clear, it is encouraging more companies to follow. Development of transport and logistics infrastructure Transport and logistics infrastructure have improved significantly in the period of China s eleventh Five Year Plan ( ). Although it has yet to achieve the standards of many developed economies, China is far better connected across counties and provinces than before. This is helping to lower the transportation cost and facilitate the development of a national logistics market which is aligned to the policy direction of the Chinese government. With more transport facilities such as toll roads being built with provincial government funding as well as private sector investment, we expect there will be more such projects seeking to raise capital, including through initial public offerings in the near future. Market consolidation China s logistics market is fragmented and dominated by companies with limited scale or offering a limited scope of logistics services. With improvements in infrastructure and the government s policy aim being to nurture a number of large, internationally-competitive logistics enterprises, we expect increasing numbers of mergers and acquisitions. There are a few regional players emerging but they are still facing some obstacles when expanding across provincial boundaries. One notable trend is horizontal integration by means of cross-provinces M&A, as a means to gain access to the bigger domestic markets. The sources of capital for the industry are still largely limited to government funding (by state owned enterprises) and bank loans. With the market continuing to develop and the decline of government funding, the role of capital markets and private equity as sources of capital will become more important. 6 State Council of the People s Republic of China

Fast Forward: What s next for China s logistics sector 9 Foreign investment considerations Market entry considerations When considering an investment in China s logistics sector, attention to tax

11 Fast Forward: What s next for China s logistics sector 9 Foreign investment considerations Market entry considerations When considering an investment in China s logistics sector, attention to tax structuring options can help identify, address and reduce tax leakages, enhancing returns to investors. The choice of investment holding structure may be affected by the investor s home country tax treatment and investee country s imposition of withholding tax on profit repatriation. Efficient structuring can help to minimise tax leakages on repatriation of profits and minimise capital gains tax when exiting an investment, while addressing cash trap issues. China s Corporate Income Tax (CIT) Law, introduced in 2008, has leveled the playing field between domestic and foreign companies, creating a uniform corporate income tax rate. Many preferential tax policies offered to foreign investors have been removed, but some industryfocused tax incentives do still exist. Investors should remain aware of local tax practices and consider where it is necessary to register for, and pay, income and turnover tax under different business models. The imposition of a dividend withholding tax under the CIT Law has resulted in many foreign investors considering Hong Kong as a suitable location for an intermediary holding company for China investment. Provided certain conditions are met, this allows the PRC dividend withholding tax to be reduced from 10 percent to 5 percent under the PRC Hong Kong Double Tax Arrangement. Investors should also ensure that any holding structure adopted has commercial substance. Otherwise, the anti-avoidance provisions under the CIT Law can be applied by the PRC tax authorities to cancel out the tax benefits obtained. Transfer pricing and the tax efficient supply chain Many global logistics companies are entering the China market or expanding their operations in China. Many of them are altering the scope of inter-company transactions and applying their global network to enhance logistics services within China. To make sure the network operates effectively and appropriately, the head office and other overseas subsidiaries must co-operate closely with the Chinese entities. This cooperation has led to an increasing number of inter-company transactions. As China s tax authorities step up their efforts to enforce comprehensive transfer pricing rules, companies can gain an advantage over their competitors by adopting efficient transfer pricing measures. Transfer pricing can have important implications across the evolving supply chain structure, to both direct and indirect tax liabilities. Multinational logistics companies should consider transfer pricing and corporate tax issues in a holistic manner. From a transfer pricing perspective, they should be aware that if inter-company transactions do not take place at arm s length, transfer prices will face scrutiny from the State Administration of Taxation. From the corporate tax perspective, they should pay attention to the tax liabilities of the Chinese subsidiary and be aware that some inter-company transactions will be subject to China corporate income tax. To fully benefit from their investments in China, multinational companies need to strike a balance between compliance with transfer pricing regulations and enhancement of tax efficiency through proper supply chain management.

12 10 Fast Forward: What s next for China s logistics sector Major logistics hubs in China Urumqi Xining Lhasa Chengdu Kunming Jinghong Source: KPMG Research

13 Fast Forward: What s next for China s logistics sector 11 Harbin Changchun Hohhot Beijing Shenyang Lanzhou Yinchuan Tianjin Shijiazhuang Taiyuan Jinan Dalian Qingdao Xi'an Chongqing Zhengzhou Nanjing Wuhan Hefei Hangzhou Changsha Nanchang Shanghai Ningbo Guiyang Fuzhou Nanning Xiamen Guangzhou Shenzhen Hong Kong Haikou National hubs Regional hubs

12 Fast Forward: What s next for China s logistics sector About KPMG KPMG is a global network of professional firms providing Audit, Tax and Advisory services.

The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss cooperative. Each KPMG firm is a legally distinct and separate entity and describes itself as such.

14 12 Fast Forward: What s next for China s logistics sector About KPMG KPMG is a global network of professional firms providing Audit, Tax and Advisory services. We operate in 144 countries and have 140,000 people working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss cooperative. Each KPMG firm is a legally distinct and separate entity and describes itself as such. KPMG China KPMG China has more than 9,500 professionals working across 13 offices. These offices are located in Beijing, Shenyang, Qingdao, Shanghai, Nanjing, Chengdu, Hangzhou, Fuzhou, Xiamen, Guangzhou, Shenzhen, Hong Kong and Macau. Our experience For over 60 years in this region, KPMG has built a reputation for providing quality services to a wide range of clients in both the private and public sectors. Our single management structure allows efficient and rapid allocation of resources wherever our clients are located in China. Global Transport Group At KPMG, we are committed to providing quality services to our clients. In recognition of the fast growth occurring in the transportation and logistics sectors, KPMG has formed the Global Transport Group, enabling us to share industry knowledge and training amongst member firms. This allows us to assist clients in pursuing opportunities and implementing changes necessitated by the growth and the development of the industry. This multi-disciplinary group comprises of a large number of transport sector specialists with extensive knowledge in serving clients globally on audit, tax, due diligence, and other advisory services.

15 Fast Forward: What s next for China s logistics sector 13 Contact our Transportation and Logistics team: Andrew Weir Jeffrey Wong Benny Liu Partner in Charge Partner Partner China, Asia Pacific Shanghai Guangzhou Tel: Tel: +86 (21) Tel: +86 (20) andrew.weir@kpmg.com jeffrey.wong@kpmg.com benny.liu@kpmg.com Simon Ho Stephen Ip Karmen Yeung Partner Partner Partner Beijing Transaction & Restructuring Tax Tel: +86 (10) Tel: +86 (21) Tel: simon.ho@kpmg.com stephen.ip@kpmg.com karmen.yeung@kpmg.com Li Fern Woo Lewis Lu Jonathan Downer Partner Partner Partner Shanghai Tax Hong Kong Tel: +86 (21) Tel: +86 (21) Tel: lifern.woo@kpmg.com lewis.lu@kpmg.com jonathan.m.downer@kpmg.com Chi Cheng Michael Lai John Timpany Partner Partner Partner Tax Risk & Compliance Tax Tel: +86 (21) Tel: +86 (21) Tel: cheng.chi@kpmg.com michael.lai@kpmg.com john.timpany@kpmg.com John Ip Jacky Muk Alex Capri Partner Partner Partner Performance & Technology Chendgu Trade & Customs Tel: Tel: +86 (28) Tel: john.ip@kpmg.com jacky.muk@kpmg.com alex.capri@kpmg.com

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