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Asian Emergence: The Brave New World of Logistics

Innovation was once viewed as the bastion of the United States. In 1790, George Washington authorized the first U.S. patent, granting Samuel Hopkins the right to a new manufacturing method for potash. Today, 216 years later, both manufacturing and innovation have gone west, from the United States to Asia. As a result, we are in the midst of a sea of change that is revolutionizing the global economy, and in tandem, the logistics world.

by Benjamin Gordon

This article highlights the global changes driven by the trend toward Asia, and the resulting winners and losers in logistics.

India and China: Getting Big Fast

To understand the changes in Asia, it is instructive to start with China, since China along with the United States represent a combined 60 percent of global trade.

Today China, along with India, stands at the epicenter of the Asian miracle. The two countries represent a population of 2.2 billion. In addition, both are attracting foreign direct investment, with China attracting $60 billion, and India drawing $3 billion. Overseas firms like Yellow Roadway (YRC), DHL, and GeoLogistics are attracted by the significant growth potential in India and China. The Indian logistics market represents $15 billion, according to Frost & Sullivan, and is growing at a rate of 7 percent annually. Meanwhile, China weighs in at $250 billion of logistics spend according to UPS, and is growing 16 percent annually.

An important engine of growth is China's 2001 acceptance by the World Trade Organization (WTO). As a result, China must now adhere to WTO's rules, and is liberalizing rapidly. In the past four years, China has reduced tariffs from 25 to less than 10 percent. Continued legal changes attract more overseas investment and fuel accelerated expansion.

Another key driver of Asian logistics growth is the low level of logistics outsourcing. Both China and India have under-penetrated, third-party logistics (3PL) markets. India's 3PL sector represents 3 percent of the country's total logistics spend. China's 3PL sector represents just 2 percent of its country's total logistics spend. In contrast, the U.S. 3PL sector is much more penetrated, at approximately 10 percent, with Europe even higher, at 25 percent. Clearly the Asian 3PL sector has a lot of room to grow.

A core reason for this low penetration in the Asia market is their low efficiency. In the United States, over the past 25 years, logistics costs as a percentage of GDP has declined from 17 to 9 percent. In China, logistics costs today represent 21 percent of GDP. In the U.S., logistics costs declined due to a combination of government infrastructure investments and high-growth, asset-light outsourcing logistics companies. These trends are also increasing in both China and India.

The governments of India and China are investing aggressively to fuel accelerated growth. India, for example, whose logistics market is approximately 0.7 percent of the U.S. logistics market, announced plans for $17 billion in transport infrastructure investment between 2006 and 2010. In contrast, the United States just signed into law SAFETEA-LU, a $286.4 billion, six-year spending plan for transportation infrastructure that equates to 5 percent of its annual logistics market. Thus, on a per-annum basis, while the United States is investing 5 percent of its annual logistics spend on infrastructure, India is investing 23 percent or over four times as much.

Asian business leaders see these trends and are responding by seeking outsourcing solutions. A survey by Harris Interactive and sponsored by UPS indicated that Asian executives are seeking to outsource at a rate three times faster than that of their U.S. and European counterparts. When asked whether they are moving "very extensively" or "completely" to outsourcing, 29 percent of Asian executives said yes. In contrast, just 11 percent of U.S. and European executives agreed with this assertion. As a result, logistics markets are opening up and growing rapidly throughout China, India, and indeed much of Asia.

Impact on U.S. Logistics Markets

The impact of Asia's ascendance on U.S. logistics markets has been swift.

First, manufacturing has shifted from the United States to Asia. In November 2005, General Motors (GM) declared plans to slash 30,000 jobs in Canada and the United States. Days later, GM announced plans to add 450 workers in India, and 200 in China. In the next 3 years, GM intends to raise auto parts sourcing in India from $120 million to $1 billion, and up to $80 billion in China.

Second, carriers and freight forwarders have gained significant benefits. In November 2005, three North American carriers - American, Continental, and Air Canada - initiated service to Delhi.

Third, the West Coast of the United States has continued to register record levels of demand. As Asian-based manufacturing is shipped to the United States for consumption, the ports of Los Angeles and Long Beach are reporting record volumes. Los Angeles, for instance, handled over 700,000 Trailer Equivalent Units (TEUs) in the month of October alone. In the coming year, China will originate over 48 percent of all import freight into the United States, much of it via the West Coast. California-based firms have grown correspondingly. For example, California-based freight forwarders GeoLogistics and BAX Global have both completed successful turnarounds in the past five years, expanding from unprofitable operations in 2000-2001 to over $50 and $100 million in operating profit, respectively, on the basis of dramatic Asia-U.S. freight forwarding growth.

Consolidation is Coming, in China and throughout Asia

The rapid ascent of China has caught the attention of global logistics leaders.

In China, over 150 merger and acquisition transactions have taken place with U.S. companies over the past decade. Companies like GeoLogistics, YellowRoadway (YRC), and others have forged deals to enter China. Historically, U.S. companies seeking growth in Asia have targeted the Western-friendly markets of Hong Kong and Singapore. Mainland China, after all, didn't even have a stock market until 1990, and many of the core assets of the country remain under government ownership.

However, this acquisition approach is changing rapidly, as companies target mainland China as well as neighboring markets. According to MidMarket Capital Advisors, two-thirds of Chinese acquisitions in the United States have been conducted as 100 percent transactions through Hong Kong entities. In contrast, two-thirds of U.S. acquisitions in China have involved majority investments in mainland China. This activity is expected to continue to surge.

This trend is also seen in other parts of Asia. In India, DHL purchased Blue Dart, establishing a foothold in the domestic courier and express marketplace. FedEx and UPS are also strengthening their positions in the country, and recently increased the number of flights in and out of China.

Implications for U.S. Companies

For U.S.-based logistics providers, the implications are monumental.

On the one hand, companies that gain a successful foothold in Asia can expect to see significant growth. U.S.-based companies like Expeditors, BAX Global and GeoLogistics now derive a majority of their profits from Asia. In a market where logistics companies were historically valued at 5-7 times operating profit, or EBITDA, the high valuations (Expeditors trades at close to 20 times EBITDA, BAX sold for 11 times EBITDA, and GeoLogistics sold for 14 times EBITDA) reflect the premium markets, investors, and buyers place on Asian growth opportunities. Similarly, when PWC Logistics announced a string of three acquisitions to strengthen its presence in Asia in 2005, its market valuation skyrocketed from less than $2 billion to over $8 billion, in a large part due to the premium that investors placed on the company's Asian expansion.

On the other hand, companies that overlook Asia do so at their peril. Much like the European manufacturers of the 1800s, who found themselves supplanted by Samuel Hopkins and other leaders of the U.S. manufacturing golden era, U.S. companies today who fail to invest in Asia will eventually slip behind. For example, Expeditors grew its market value by 20.3 percent over the past five years. In contrast, EGL, a firm with a weaker Asian presence, grew its market value at half that rate, or 9.5 percent. Smaller firms face an even more dramatic impact, as freight forwarders with a subscale presence in Asia-U.S. trade lanes are finding themselves increasingly shut out of lucrative markets by larger competitors.

Smart logistics companies have several options for responding. Some, like BAX and GeoLogistics, sought mergers with the global firms of Deutsche Bahn and PWC Logistics, respectively, gaining resources to fund accelerated growth in Asia. Others are raising capital in a bid to fund acquisition-led growth while maintaining independence. What is clear is that every U.S. logistics firm needs a strategy for growth in what may be known as the Asian century.