The Global Rail

By Dave Holloman

January 6, 2009

A key supply chain challenge in the coming decade will be serving the Chinese consumer.  For many companies, doing so effectively will enable companies to tap the next growth wave in the global economy.

As the global economy stabilizes, eyes are turning to the Chinese consumer as an increased source for growth.  In the developed world, especially the US, debt-laden consumers are not expected to be the growth engine they once were.  In the past boom, consumer spending accounted for 2/3 of the US GDP, powering US growth and exports from abroad.  Yet, according to a recent column by Paul Krugman, US consumers are $11 trillion poorer compared with the start of the current recession.  The US consumer will likely be focused towards budget, not spending in the foreseeable future.  Just in time it seems, indications are that Chinese consumers are spending more.  This year, China may well pass the US as the largest consumer market.  The Chinese government recognizes the situation and its potential, viewing domestic consumers as the available source to replace waning export demand.   They are using numerous policies to support this transition.  Consumer lending by state-owned banks is increasing.  Tax incentives are being offered.   These steps are having an effect.  Retail sales growth in China was 17% this past year, as highlighted in a recent article in the New York Times.  And there is plenty of room for continued growth. A recent report by The McKinsey Global Institute highlights that consumption is only 36% of total China GDP, only half of US levels and 2/3 of levels in other developed economies.  This transition has been a trend for more than a few years, one that will accelerate and deepen as a new world order emerges with the economic recovery.   As these trends continue, the Chinese consumer will become the primary power underpinning next phase of global growth.

This emerging reality is not how current supply chains are designed.  Helped by a low exchange rate (some say artificially low) and US consumer spending, China became the source of supply as the first stop in a global supply chain.  The primary supply chain focus in China was tapping low labor costs to supply consumers elsewhere.  This will change.  The issues regarding Chinas’ fixed exchange rate will come to a head sooner rather than later.   Once they do, the supply chain model of using China primarily as a source of production in the global supply chain will end.  When it does,  supply chains will need to be reconfigured to serve the Chinese consumer and tap the next economic growth engine.

This transition will be complex.  First is the transition to a new supply chain network itself.   Certainly, companies can benefit from a burgeoning third-party logistics sector, benefiting from foreign entry in 2006 in conjunction with China’s WTO membership.  Even with this accelerator, the number of new  processes to change and create represents significant business change.  There is more complexity on the horizon.  Funded by massive government spending, China is currently building out its infrastructure of road, rail, and shipping on an unprecedented scale (see The Other Stimulus).  The speed of build-out in each of these areas is at a magnitude not seen in history.   In the four years leading up to the latest, increased round of investment, over 600,000 km in new highways were built.  More high-speed rail has been put in the ground in the last four years than in the last 20 across all of Europe.  As networks transition to serve demand domestically, keeping up with the dizzying pace of change will be an added challenge.

These two challenges are coupled with high risk factors.  AMR, a research institution, has called China the “world capital in supply chain risk.” This is primarily due to fears of IP infringement and also the cost of corruption.  A recent government audit suggests corruption is a $35 Billion dollar problem, annually.   These challenges will be faced and solved by companies seeking to go where the growth is.

The recent economic downturn, the most severe since the great depression of the 1930’s, has accelerated existing trends.  One of those trends is the emergence of the Chinese consumer class.  Supplying the demand for this emerging force will be one of the primary business challenges this decade.  Those who meet that challenge will be rewarded.