China's Last Mile Conundrum

September 5, 2017

 

 

Earlier this year, China’s National Bureau of Statistics released China’s report with the economic data for 2016. It came as no surprise that China’s online shopping is experiencing a historical boom. Already the largest eCommerce economy in the world, China expects its eCommerce market to continue its aggressive growth pace over the next few years.

 

The volume of online sales in China already exceeds that in the US and is expected to grow 20%  annually through 2020.

 

What are some of the drivers behind this growth?

 

Socioeconomic Growth

Since initiating market reforms in 1978, China has shifted from a centrally-planned economy to a market-based economy.  This has yielded rapid economic and social development. GDP growth has averaged nearly 10 percent a year—the fastest sustained expansion by a major economy in history—and has lifted more than 800 million people out of poverty. China reached all its Millennium Development Goals (MDGs) by 2015 and was a major contributor to the achievement of global MDGs. Although China’s GDP growth has gradually showed since 2012, it is still impressive by current global standards.

 

With a population of 1.3 billion, China is the second largest economy and is increasingly playing an important and influential role in development and in the global economy. China has been the largest contributor to world growth since the global financial crisis of 2008.  According to a McKinsey study, by 2022, 76% of the population will be middle class, or roughly 550 million people.   Coupled with a low household debt-to-GDP ratio, 40% vs 88% in the US, Chinese likely have a higher propensity to spend.

 

Mobile Payment

According to Forrester’s latest research, the rate of growth in China’s mobile payment has clearly surpassed that of the US. In 2016, Chinese consumers spent 50 times more money on mobile payments than their American counterparts.  Wechat and Alipay, which accounted for $2.9 trillion in transactions in 2016, surprisingly accounted for only 63% of digital payments. These platforms unlocked a previously untapped market value, estimated $236billion.

 

What does that mean? Evidently, Chinese consumers are not afraid of shopping online. As a result, in China, market penetration is easier for eCommerce; in contrast to in other countries where hard currency and credit cards are still the norm, representing the majority of payments.

Furthermore, online shoppers are the embodiment of the China’s growth story; they are young, urban, and highly educated. They have a different attitude towards shopping from their predecessors, who were shaped as savers by challenging political and economic circumstances.

 

Younger shoppers are willing to spend. They might window shop in the numerous malls being built in China, but when it comes to spending the money, they will go online and buy the items there, also making the most of free delivery and free returns within 7 days.

 

Municipal Decentralization

In response to rapid population growth and increased pollution, major cities in China are now focused on enforcing regulation and curbing population growth.  As a result, non-residents (a.k.a. migrants) are leaving major cities.  

 

One such effort to “clean up cities” is to raze traditional wholesale and wet markets.  Low-wage migrant workers, who arrived decades ago in search of money and opportunity, are swept up in this cleansing as unlicensed vendors are shut down.

 

With numerous eCommerce players looking to fill these gaps, both in B2B and B2C, purchasing has become even more streamlined.  Online’s ability to aggregate volume across a broader geography, while conveniently saving on retail space rental, has also helped increase consumer bargaining power.

 

In short, changing city demographics has led to less shops, more online merchants, and more deliveries.

The Challenges of Last Mile

 

The rapid development of eCommerce in China has spurred similarly explosive growth in the country's express delivery industry, with volumes rising more than 50% year-on-year since 2010, according to State Post Bureau data.

 

An estimated 20 billion parcels were delivered via express services last year, generating revenues of over 265 billion yuan (US$40.7 billion). Such rapid growth, however, has not come without problems, including damaged, delayed and lost packages.

 

These difficulties have been concentrated in the so-called last mile, the final step in the delivery of goods from storage depots to the hands of purchasers.  While the last mile of the supply chain may be the shortest physical stage in a package's journey, it represents about 30% of total delivery costs. The cost of delivering vegetables from wholesale markets in suburban Beijing to in-city retail outlets is four times that of delivering from farms in far more distant Shouguang in Shandong Province.

 

One underlying factor for the inefficiency is that companies overwhelming rely on in-house delivery over third-party logistics providers.  In Europe and Japan, third-party providers account for 70% of deliveries, meaning there exists a consolidation of delivery infrastructure and resources. In China this number is 25%, resulting in a whopping 6,000 delivery points in Beijing alone.  Each courier delivers fewer than 40 items per day, an estimated wasted capacity of up to 50% of total costs.

 

Another key factor is local laws to regulate traffic and transport. In Beijing, trucks entering Fourth Ring Road (a 16km by 16km square surrounding the city center) are required to have a special transportation license.  In addition, they are only allowed in the city after 10:30p.m.. In Shanghai, truck passes are capped and delivery times are restricted.  While these regulations curb pollution and reduce traffic, they significantly impact deliveries, with some companies even doing “endless van loops” throughout the day between warehouses and city distribution centers.

New Solutions For Last Mile

 

Caught between government regulations to decrease heavy trucks within cities, and escalating volumes of deliveries, many companies are emerging to implement new alternatives for Last Mile doorstop deliveries.

 

Delivery Lockers

On June 1, 2017, a spat between two of China’s key logistics players forced all industry players to draw allegiances between two sides.  At the heart of the issue was Delivery Lockers and data.  Cainiao, affiliated with the Alibaba group and closely tied to Taobao, had asked all delivery companies on the Taobao platform to share locker delivery verification information.  SF Express, the leader in express deliveries, declined, citing Cainiao asking for delivery information unrelated to Taobao platform sales; they viewed this as a breach of consumer privacy. Cainiao’s retaliation of having SF Express data removed from the Taobao platform resulted in chaos, particularly with cold chain deliveries which require real-time tracking access.  The government quickly stepped in and forced both parties to the reconciliation table.

 

So what are delivery lockers and why are they so important?  Delivery lockers are “mini depots” from which customers can pick-up goods. They are part of the solution to the challenge of undelivered products.  Companies such as JD.com, Chengdu Santai Electronic Industrial's Sposter network and Fengchao Kuaidigui, a new venture backed by SF Express, are among the businesses trying out this new model.

 

Switching the final step in the logistics chain from courier delivery to self-pickup by consumers reduces business complexity and cost. In exchange for consumers sharing in the last-mile burden, companies provide compensations in the form of discounts or special offers.

Setting up a locker system costs around 40k RMB, with the upfront investment recovered via charges for extended storage, subsidies from eCommerce and delivery companies, and advertising on the actual unit. According to State Post Bureau data, some 15,000 lockers were put into use in 2014 and handled 1% of total delivery volumes.

 

Retail Shops as Pickup Points

In 2011, Amazon US partnered with 7-Eleven stores to use convenience stores as delivery pick-up points.  In-line with this model, City100 and Shenzhen-based Mail World are allowing customers to pick up from high-traffic areas such as schools, community centers, and even nail salons.  These businesses bundle additional services not just limited to package pick-up.  For instance, recipients can at the same time top-up their mobile phones and purchase train tickets, while saving 1-2RMB per delivery of their packages.

 

Going one step further, some delivery and eCommerce companies are setting up their own storefront networks. Imagine not just picking up the delivery of a new outfit, but also trying it on onsite and being able to send it back for returns immediately.  

 

Crowd Delivery

A third approach leverages unused or underutilized labor for "crowd delivery". Echoing the business model of Uber, JD.com and Alibaba have programs utilizing small-shop owners and freelancers to handle last-mile delivery.  For 6 yuan per parcel, the company's centralized scheduling system matches willing couriers according to location, delivery time and customer rating with parcels awaiting delivery. Social network Renren began offering crowd delivery in 2013 and now has 1 million independent couriers using its platform.

 

The emergence of lockers, third-party platforms and crowd delivery have shown that the problems in China's delivery sector are not just around logistics but also related to cross-sector business model innovation and application. Internet-based advances and integration between online and offline retail are generating solutions to the last-mile problem and will overtake existing business models for eCommerce and courier companies.

To keep up with the increasing demand from smaller urban and rural areas, online retailers are seeking to expand logistics infrastructure and services. With a need to resolve Last Mile inefficiencies, large established players are moving down the value chain, by building their own fleets or reselling their delivery services to smaller players, thereby consolidating volume.  In parallel, fleet technology businesses are expanding to warehousing solutions and parcel management services.  In short, lines are blurring as players from different segments of the logistics industry cross over into new areas of expertise.

 

China’s torrid growth in online shopping reflects an increase in income, trend towards higher education, and more sophisticated purchasing patterns; these patterns do not appear to be cooling down.  With more and more technology based delivery businesses replacing traditional brick-and-mortar, it appears that growth in China’s logistics industry has not yet reached a balance with consumer demand, and will continue to grow rapidly in the near-term.




 

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