Photo: Deloitte & Touche USA LLP

Focus: Distribution and Logistics

Intermodal Revolution

Investments in the Yangzi River transport corridor will make access to China's interior easier

by Clarence Kwan and Kris Knutsen

Of the world's great rivers, the Yangzi has the greatest potential for commercial development. Winding its way 5,920 km from eastern Tibet to the East China Sea at Shanghai, the river's navigable half flows through some of the world's most populous and productive regions. More than 400 million Chinese live within its basin, and the seven provinces along its banks account for 40 percent of China's GDP. To integrate China's interior more closely with the global economy, the PRC government has spent billions of dollars in recent years to facilitate intensified use of the river. For foreign investors looking to expand operations away from the maturing markets of the coast and lower production costs, the transformation of the Yangzi River into a modern intermodal transport corridor may prove to be one of the most significant developments of 21st century China.

Go west

The creation of a comprehensive transportation system that incorporates river, road, and rail links in the Yangzi River valley is necessary to surmount the daunting logistics challenges China's geography presents—namely, the mountain chains that divide the prosperous coast from the less well-off interior. In 2000, the PRC government launched the Great Western Development Strategy, which boosts public spending on infrastructure and offers private investment incentives to encourage industry to migrate inland. As part of the campaign, China spent $123 billion between 2001 and 2005 to add about 25,000 km to its national expressway system, a network that will eventually surpass that of the United States in length. Virtually all of the completed and scheduled expressway construction projects are in China's interior. China is also making its western region a focus of its campaign to modernize and expand its massive but strained rail system. Huge upstream industrial hubs such as Chongqing and Wuhan, Hubei, which serve as major markets and distribution centers, are now poised to benefit as this new infrastructure is completed.

Containerizing the inland economy

To integrate with the global economy, China must containerize its inland economy. Since their introduction in 1956, containers have transformed international trade by allowing a remarkable variety of goods to travel over huge distances and be transferred from rail to truck to ship with maximum efficiency and minimal risk in terms of theft or damage. From advanced tracking and tracing technologies to emerging port security initiatives, containerized transit has recently played a key role in bringing the fruits of the global communications revolution to the shipping industry. These advances have pushed global transportation costs down sharply, with the average cost of maritime shipping as a percentage of the total retail cost of manufactured goods falling 80 percent in the last 20 years.

Lower transport costs have also greatly facilitated China's rise in the global economy. In 2005 alone, Chinese coastal ports handled 75 million 20-foot equivalent units (TEU), up 20 percent over 2004. The PRC government now projects that these ports will handle more than 140 million TEU by 2010. Three of the world's top five container ports (Hong Kong, Shanghai, and Shenzhen) serve China, and containers leaving or arriving at China's shores now constitute 27 percent of the world's total containerized cargo. The problem for China is that few of these containers travel far from the main coastal ports, and foreign investors hesitate to extend their supply chains further inland until both the physical infrastructure and advanced logistics providers are in place to serve them.

Global 3PL companies enter the fray

With logistics costs representing 21 percent of its GDP—more than double that of the United States, Japan, and most European countries—China is already shifting its attention from physical infrastructure (hardware) to developing a modern intermodal system (software) capable of achieving its development goals. To this end, China will benefit from foreign participation in its logistics sector. In line with its World Trade Organization commitments, China lifted all foreign ownership restrictions on freight forwarding, road transport, and warehousing and storage services by December 2005 (though it must still lift its restrictions on courier services). Foreign players are now free to compete with China's flood of new market entrants looking to cash in on increased trade and low start-up costs.

Currently, about 15,000 third-party logistics (3PL) companies operate in China, though the quality and type of services they offer vary widely. Growth has been strongest in the coastal areas where the influence of the global industry has been strongest; inland domestic companies are among the least competitive in terms of equipment, information technology (IT), and management practices. The PRC government is seeking to consolidate the sector by clamping down on unregistered businesses and, in late 2005, announced a plan to bring more than 300 industry standards into line with global norms.

At present, three forces dominate China's 3PL landscape: the old state-owned enterprises, advanced global 3PL providers, and efficient domestic companies from China's increasingly robust private sector. Though China's 3PL market is still small compared to those of in the United States, Europe, and Japan, it has been growing 25 to 30 percent annually in recent years and is viewed as highly strategic by the global 3PLs. Most are now busy extricating themselves from sub-optimal partnerships, either by buying out their joint venture partners or forging new relationships with domestic players on a stronger footing. Drastic industry consolidation seems inevitable, and as new services and technologies now common on the coast are introduced to the interior, greater efficiency will translate into lower costs.

Comparing Freight Transport Costs, 2005
Chongqing-Shanghai	Distance (km)	Transit Time (Days)	Cost
Road	2,150	3-4 (40 hours)	$0.10 per ton/km*
Rail	2,600	7-10	$770/TEU*
Barge	2,400	8 (11 upriver)	$395/TEU
Chongqing-Wuhan
Road	700	3	$0.10 per ton/km
Rail	1,000	6	$545/TEU
Barge	1,280	4 (6 upriver)	$340/TEU
Fierce competition among trucking firms on busy coastal routes can bring rates down to $0.06 per ton/km. TEU = 20-foot equivalent units Source: Chang'an Minsheng Logistics

Road transport

Because of its speed and flexibility, trucking has emerged as the most viable, but expensive, way to move most goods over long distances in China.

Because of its speed and flexibility, trucking has emerged as the most viable, but expensive, way to move most goods over long distances in China. About 75 percent of the freight value moved in China today is shipped by truck, although little of this traffic is containerized. Over the past five years, new expressways have greatly improved inter-city travel; new routes often cut the transit time between Chinese cities in half.

Yet the future of long-distance trucking in China is by no means assured. Moving all but the most valuable or time-sensitive goods by road may soon make even less sense given China's priorities to reduce urban congestion and environmental degradation and to become less dependent on imported fuel. Moreover, construction of the expressway system has already led to steep toll rates—often as high as ¥1.50 ($0.19) per km for the three- to five-ton trucks that form the backbone of China's trucking fleet. The rising cost of fuel—the retail price of diesel fuel rose 11 percent in late May alone—and the possibility of a 20 to 30 percent fuel tax in the near future pose further obstacles. (Trucks are the least fuel-efficient way to transport goods over long distances. According to US government estimates, one gallon of diesel will carry one ton of goods 96 km by truck, 325 km by rail, and 828 km by barge.) As Chinese take to the highways in greater numbers every year, congestion and pollution will also grow. Though trucks will always play an integral role in any intermodal system, if only to move goods from railheads and port facilities to warehouses and factory loading docks, the PRC government will likely encourage other transportation modes to shoulder more of the burden.

As the trucking sector—a fragmented industry even by Chinese standards—opens to foreign investment this year, these cost pressures will weigh heavily on China's estimated 2.5 million trucking companies. Because they can afford to use the latest technologies, foreign trucking companies just entering the market are most likely to benefit from government incentives to use fuel-efficient vehicles. Inland trucking firms—many of which are still small-scale operations, undercapitalized and deploying few, if any, IT technologies—will be most vulnerable. Many inland markets have already witnessed the arrival of more advanced private companies from the coast, some deploying global positioning systems (GPS), online billing, and other international best practices. As the road transport sector opens fully to foreign investment in 2006, fierce competition should improve conditions for investors in the region at the expense of many of the smaller domestic transport companies.

Rail transport

Rail is the natural alternative to road in a country the size of China. But unlike trucking, rail has a reputation for slow and unpredictable service.

Rail is the natural alternative to road in a country the size of China. But unlike trucking, rail has a reputation for slow and unpredictable service—especially away from China's main north-south corridors and for low-volume shippers. China's 75,000 km rail system accounts for one-sixth of the total global track length, but it already contends with one-quarter of the world's total transport volume. As a consequence, freight demand has outstripped supply on virtually every major route in the last 20 years. For the foreseeable future, priority of movement on China's single-track lines—still 70 percent of the total network—will go to passengers and bulk cargo, especially coal. Containerized freight accounted for just 3 percent of total freight volume in 2005, and most freight is still shipped in local containers that are considerably smaller than the international standard. These trains must also traverse some of the world's most challenging geography by means of bridges and tunnels. Clearance for most of China's 5,400 rail tunnels is low by modern standards, and electrification is achieved by low-hanging catenary wire. These factors have complicated the introduction of double-stack container trains, a common cost-saver on European and US rail routes, although China's Ministry of Railways (MOR) is working to remedy this situation.

To accelerate containerization of the rail system, MOR formed the China Railway Container Transport Co. (CRCTC) in late 2003. As the country's sole intermodal rail operator, CRCTC has since embarked on a wide range of initiatives designed to improve intermodal transport throughout the country. The company has assembled its own fleet of container-ready flat cars and a variety of containers and has also introduced tracking for intermodal shipments.

CRCTC's most important legacy will be the establishment of China's first dedicated container-handling rail stations. In December 2005, the company inaugurated in Shanghai the first of what will become a nationwide system of 18 major intermodal rail hubs and 40 mid-size stations strategically located at ports and inland economic centers (see the CBR July-August 2005, p.8). The network is designed to rationalize container traffic at more than 600 mixed-use facilities currently used by CRCTC. A second hub, in Kunming, Yunnan, will open in mid-2006, with other major hubs planned at Chongqing and Wuhan. Each facility will be among the largest rail freight stations in Asia, covering 6 to 12 km² and with the capacity to move 200,000 to 300,000 containers a year.

Double-stack container service will eventually link all facilities, and the system will greatly benefit from MOR's plans to segregate passenger rail routes from freight lines. This network is at the heart of MOR's ambitious plans to invest $243 billion (including private capital) to upgrade and expand the entire rail system to 100,000 km by 2020. Most of these improvements will not become fully operational until after 2010.

River transport

With challenges ahead for the long-haul trucking industry and rail not yet ready to meet growing demand, improving the Yangzi River's shipping capacity is clearly crucial to better transport to China's interior. To improve navigation, officials have implemented a series of low-cost, high-impact measures on the Yangzi over the past five years, including demolishing underwater reefs, dredging, installing riverbank navigational aids, and requiring all river barges to use GPS. Still, the central government reports that shippers are currently using just 15 percent of the Yangzi's total capacity.

Efforts to expand container-on-barge service along the Yangzi will also become more important. Barges have served as the most reliable and cost effective means of moving commodities along the river for centuries, and significant barge capacity has recently shifted to carrying containers. In early 2006, about 35 major barge companies provided container service to 24 Yangzi ports that extend 2,400 km upstream from Shanghai. Of these, the top five companies controlled about 50 percent of capacity. China, like many other countries, does not permit foreign-owned vessels to move freight on its inland waterways, but more than 20 international shipping companies have established close ties to the major Chinese operators and now offer a range of services complementary to international container transport. Since 2001, several have arranged dedicated barge service for their international customers heading inland.

As barge operators take advantage of improved navigation on the river and shift capacity from bulk to container, central and local governments have made massive investments to construct or upgrade container ports on the river. Until five years ago, facilities upriver from the major transshipment port of Nanjing, Jiangsu, ranged from large but capital-starved operations at Wuhan and Chongqing to little more than seasonal truck landings. Even at the more advanced middle and upstream terminals, harbor cranes, yard tractors, and other standard container-handling equipment were largely absent before 2000. For an operation as information-intensive as a modern port complex, the lack of modern IT systems was also a serious handicap.

New investment has changed this picture dramatically. About 24 container-capable ports are now operational as far upstream as Sichuan, and container traffic along the river has more than quadrupled since 2000. In the short term, the Yangzi's expanding container capacity will plug critical gaps in the existing road and rail networks and link huge areas of central and southwest China to the coast at relatively low cost. Over the longer term, viable container-on-barge service will serve as a useful check on costs throughout the region's intermodal system.

Yangzi River's Top 10 Container-Handling Ports, 2005
Port	Throughput (1,000 TEU)	Growth over 2004 (%)
Nanjing, Jiangsu	587.7	20
Zhangjiagang, Jiangsu	377.1	15
Nantong, Jiangsu	301.2	20
Taicang, Jiangsu	250.9	156
Wuhan, Hubei	178.0	27
Chongqing	170.1	15
Yangzhou, Jiangsu	157.0	20
Changshu, Jiangsu	110.0	51
Zhenjiang, Jiangsu	98.4	29
Chenglingji, Hunan	68.0	55
Source: Yangtze River Ports 2006, Alain Charles Publishing

Port developments

Two major developments along the Yangzi river are serving as catalysts for containerization of the river: the completion of the Three Gorges Dam and the opening of the Yangshan Port Complex off Shanghai in December 2005.

Three Gorges Dam

Located 1,000 km west of Shanghai, the Three Gorges Dam will profoundly affect the development of waterborne traffic on the river by the time it becomes fully operational in 2009. A two-way, five-stage shiplock, the world's largest, opened in mid-2004 and permits loaded barges of up to 10,000 deadweight tons (DWT) to pass within three hours; a smaller shiplift that can raise 3,000-ton vessels in less than 45 minutes is scheduled to go into service in 2009. Barges moving inland through the region will soon sail a reservoir that extends 660 km behind the dam from Yichang, Hubei, to the new container berths at Chongqing. Mid-way across the reservoir, a new container port with planned capacity of 400,000 TEU is under construction at Wanzhou (formerly Wanxian), Chongqing, an area already well-connected to points north and west of the river. Deeper, wider, more regulated flows of water will permit the introduction of much larger container barges on the upper Yangzi. Barges capable of moving 250 TEU will reach more than 2,400 km inland to Chongqing, compared to the 64-144 TEU capacity barges currently in use. As conditions on the river improve, China will eventually introduce barges capable of moving 300-400 TEU—equivalent to 150-200 heavy trucks.

Yangshan port complex

The second major stimulus to Yangzi container shipping is the massive increase in container port facilities in Shanghai. The $12 billion Yangshan container port opened its first facility in December 2005, adding 2.2 million TEU of container-handling capacity to what was already the world's third-largest container port. Located 32 km off the southeast coast of Shanghai, the facility completes a decade-long migration of Shanghai's port facilities from the clogged banks of the Huangpu River to the southern bank of the Yangzi at Pudong and now to open waters just 80 nautical miles from international shipping lanes. When fully completed in 2020, Yangshan will add 15-20 million TEU to Shanghai's total container-handling capacity—roughly the combined throughput of the top three US ports in 2005. With an average depth of 15 m at its 50 planned berths, the complex should easily handle the next generation of 8,000-10,000 TEU container ships that are taking to the world's seas in 2006-07.

At this stage, however, the only surface link to the port is a six-lane causeway with a capacity of just 5 million TEU per year. Also, trucks are charged tolls of up to ¥45 ($5.60) for the 30-minute trip in each direction. Rail service may eventually be introduced, but until then, shippers will need barge service to fill the gap. The causeway incorporates three arches to facilitate barge traffic to the complex, including one span for 10,000 DWT ships. Barges currently transport 15-20 percent of cargo to and from Waigaoqiao Free-Trade Zone (trucks haul more than 80 percent, rail just 1 percent), but port planners expect their share to rise well above 30 percent as Yangshan becomes fully operational. Yangzi barge companies have already begun experimenting with sea-going barges, the first of which began serving Yangshan directly from Nanjing in December 2005. These deeper draft, more powerful ships, capable of moving 250-300 TEU at a time, will significantly cut transit times on the entire river and open the possibility of direct container barge service from deep up the Yangzi to ports as far as South Korea and Japan.

Container traffic on the Yangzi has already increased rapidly as a result of these projects and other large-scale public and private investments in the basin. In 2005, barges moved more than 2.6 million TEU on the Yangzi, a 44 percent increase over 2004 and up from just 604,000 TEU in 2000. For 2006, the Wuhan-based Yangzi River Administration of Navigation Affairs estimates that container traffic will reach 3.1 million TEU. Central and local governments are now making investments that will raise capacity to 4.5 million TEU by 2010 and 15 million TEU by 2030. Port operators and a wide variety of other businesses whose fortunes are tied to China's booming coastal ports are also investing inland.

A new westward migration?

Foreign companies must consider several factors before extending segments of their global supply chains to China's interior. Indeed, for certain products and business models, it may never make sense to shift production westward. Conducting business with local officials, zone authorities, suppliers, and other business partners will likely remain more complex in the interior than on the coast for some time. And though labor costs are lower in the interior, competition for technical and managerial talent will remain intense.

But options for shipping containers along a well-integrated network of road, rail, and river transport are proliferating, to say nothing of China's efforts to link interior cities by expanded air cargo service. As in other segments of its economy, China will also have the benefit of being able to "leapfrog" the outdated technologies and infrastructure that weigh down more developed countries. Rapid application of new technologies, such as radio-frequency identification tags, will figure prominently as China's logistics industry consolidates and the strongest players compete to achieve nationwide scale. Investments in hard and soft infrastructure are setting the stage for an intermodal revolution along the Yangzi over the next 5 to 10 years, a development sure to draw greater numbers of investors westward.

Clarence Kwan (clkwan@deloitte.com) is national managing partner and Kris Knutsen (krisknutsen@deloitte.com) is manager, Chinese Services Group-USA, at Deloitte & Touche LLP in New York.

This article has been adapted from Deloitte & Touche USA LLP's forthcoming report The Yangtze River Transport Corridor.

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