China e-commerce logistics: The missing link

Online consumers have the luxury of access to their preferred shopping platforms wherever they are and whenever they want, and while they may not pay whatever they like, prices tend to be competitive with main street. Then it is simply a case of waiting for that handbag or pair of shoes to arrive from the warehouse.

Unfortunately, in China it's rarely that simple. Goods often travel thousands of kilometers through a network of services that is far less sophisticated than in developed markets. There is no carbon copy of FedEx while warehouse space is in short supply. If the country's e-commerce companies want better distribution channels, they must provide for themselves.

"Existing logistics service providers are struggling to provide cost-effective B2C e-commerce fulfillment on a nationwide basis for orders that are typically single unit and small packages," says Mark Millar, managing director at supply chain consultancy M Power Associates. "It is not like opening a shop in Shanghai or in Beijing. The physical distribution for e-commerce is much more complicated, taking in remote locations. What is the most economic means of delivery and how many orders can be handled?"

Quality of service is expected to emerge a key differentiator in e-commerce in the next 3-5 years, so prompt delivery will become a priority. A number of larger companies in the space have responded by either developing basic in-house logistics capacities or trying to create more sophisticated platforms.

It has added a new front in the battle between market leaders Alibaba Group and JD.com, formerly known as 360Buy.

Internal solution

JD.com has raised $1.7 billion in PE and VC funding in the last two years and much of this capital has been put towards the creation of a nationwide network of warehouses and delivery fleets. As of May 2013, the company had six logistics centers, 71 warehouses, nearly 1,000 delivery stations and more than 10,000 delivery staff. It promises same-day delivery in 27 cities and next-day delivery in 150 more.

"Our self-operated last-mile delivery system is a major competitive advantage. We also offer other delivery options to meet customers' needs, such as night delivery and three-hour delivery," the company tells AVCJ. "We will continue to strengthen our distribution facilities infrastructure to further improve operational efficiency and customers' shopping experience."

However, expansion comes at a huge cost. JD.com is acknowledged as the most comprehensive internal logistics provider and if it can maintain this network and turn a profit, others will take the same approach. But there is no guarantee of success as online clothing retailer Vancl can attest. Having opened 20 warehouses in 2011 to lower tier cities, the company found the process wasn't cost effective because too much inventory was building up. It has now scaled back to 6-7 core warehouses.

"For many traditional companies, warehousing and inventory control system are well-established. However, for e-commerce players, who come from a younger generation and don't necessarily have operational experience, it becomes a challenge if they don't manage logistics right," says Victor Gao, Shanghai-based managing director at CDIB Capital.

Alibaba is taking a different approach. Rather than create an entirely in-house system, it is combining the talents of existing logistics providers by signing them up to the China Smart Logistic Network. SF Express, Shentong Express, Zhongtong Express, Yuantong Express and Shanghai Yunda Express are among those who will help the company achieve greater penetration in lower-tier cities, and save on costs.

Alibaba is not contributing capital to the project, but will operate it through Cainiao Network Technology, an information platform that conveys delivery information from C2C portals Taobao and Tmall to the carriers.

"Alibaba is creating an open information sharing platform, allowing logistics players to plug in and provide services to different merchants from Taobao," says Hans Tung, Beijing managing partner at Qiming Venture Partners, which is an investor in Vancl. "It can link up with each regional delivery service provider, a bit like a franchise model. This approach can work, but service quality will differ from place-to-place."

M Power's Millar adds that the approach makes sense given China's e-commerce and logistics revolution is still in its early stages. By using an existing network Alibaba is exposing itself to less risk, but at the same time there is potentially less upside because income must be shared with the providers. This might explain why PE investors are reluctant to invest in the network, even though domestic conglomerate Fosun International has agreed to participate.

"This is a very low margin business and you have to deal with express companies, most of which are family-owned and difficult," one technology-focused GP explains. "Furthermore, there is always a risk that these express companies will end up fighting with each other."

Viable targets?

According to KPMG, there are more than 10,000 players in China's express delivery industry, and the eight largest are dominant. Five of them - SF, Shentong, Zhongtong, Yuantong and Yunda - are participating in Alibaba's project.

With the exception of China Post-owned EMS and SF, the leading express companies follow a franchise model. It is an obstacle to integration and there have been complaints of inconsistent service and poor quality control. For PE investors able to offer management and IT expertise, this can be an opportunity. For example, last month Sequoia Capital and Goldstone Investment invested $30 million in Zhongtong.

Others, though, complain about the lack of credible investment targets. At one end of the scale, SF is said to have no need to raise new funds and therefore no incentive to give up equity; at the other, are a host of nearly players that are likely to be swallowed up when the logistics industry eventually consolidates.

"There should be 2-3 private express companies with full market coverage in the market, such as FedEx or UPS in the US," says CDIB's Gao. "When it comes to competition, customers will benefit."

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• Topics
• Technology
• Greater China
• Logistics
• TMT
• China
• CDIB Capital
• Qiming Venture Partners
• Alibaba Group