Five things to know about the Chinese logistics market heading into 2022

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The COVID-19 pandemic has only accelerated development of China’s logistics industry, which was already moving at breakneck speed. For decades, the country has been a crucial node in the supply chain of companies around the globe. And while many customers in other countries only awakened to the convenience of online shopping and delivery during the pandemic, millions of drivers have long been zipping through Chinese cities to deliver parcels of all sizes.

How has the Chinese logistics market fared during the pandemic, and what’s the outlook for 2022?

In this article, we present five insights global investors, logistics companies, and shippers should be aware of. Generally speaking, surging demand for logistics services coupled with supply chokeholds resulting from pandemic lockdowns and travel restrictions have translated into a profitable year for many logistics players. The COVID-19 pandemic also sped up the industry’s sophistication. While we see greater consolidation and integration in some subsectors such as third-party logistics and express-delivery carriers, we’re also expecting growth in other areas such as warehouse automation and air cargo.

Whichever stakeholder you are, an understanding of these trends can help with your decision making for 2022.

1. Most logistics players are looking forward to another bumper year in 2022

If you’re a logistics provider, chances are 2021 was a profitable year. While the initial shock of the pandemic depressed freight volume growth in early 2020, the world recovered its appetite for more physical goods shortly thereafter. Increased savings from staying home more and government financial aid boosted people’s purchasing power for tangible products such as furniture—partly because they couldn’t spend this money on services like eating out, traveling, or getting their nails done. So as more people bought more products (many of them made in China) to upgrade their homes and convert their living spaces to offices, shipping volumes soared across all modes last year, including road freight, container, and air freight (Exhibit 1). In China, freight volumes have risen by between 1 and 14 percent since 2019 and were higher in some key trade lanes such as between the country and North America.

All modes of transport volumes have surpassed 2019 level

Even though demand soared through most of 2021, the supply of effective freight capacity struggled to keep up. Ports globally, and especially those on the US West Coast, became congested due to elevated import volumes. This, coupled with pandemic-imposed port lockdowns and the Suez Canal blockage, took capacity out of the market and sent shipping costs skyrocketing to unprecedented levels. Furthermore, fewer passenger flights coming in and out of China meant a reduction of belly cargo-carrying capacity. Between November 2020 and 2021, air freight rates between Hong Kong and Europe rose by 47 percent, from $5.40 to $7.90 per kilogram. All this translated to better profit margins for freight forwarders and increased returns for their shareholders (Exhibit 2). The average earnings (before taxes and interest) rose by 36 percent for forwarders, and even more so for carriers that owned ships and aircraft.

As a result, freight forwarders are enjoying improved profit margin

The same dynamics will probably continue into 2022, as supply chain challenges are unlikely to be resolved immediately. The emergence of Omicron and other potential coronavirus variants, along with China’s continuing zero-case policy, means that Chinese borders will remain largely closed. Container supply chain congestion and limited cargo-belly capacity should probably allow logistics suppliers to keep their high profit margins for 2022, which spells good news for their investors and shareholders.

2. The flurry of mergers among third-party logistics players will probably continue

Freight forwarders and third-party logistics (3PL) providers have been eagerly searching for ways to quench the seemingly insatiable thirst for their services. Many companies have sought to lock in longer-term capacity, expand their digital capabilities, and move toward omnichannel integration. The value of M&A activity, IPOs, and start-up deals in China shot up by more than $7 billion in 2021 compared with the previous year. The lines between freight forwarders and contract logistics providers are being increasingly blurred.

One of the most significant deals was the birth of a new Chinese logistics juggernaut in December 2021. The China Logistics Group, with a registered capital (the amount of capital that a company is allowed to get from selling shares) of $4.7 billion, was formed by a merger of five state-owned companies and is the country’s largest logistics player by revenue. By bringing together the former China Railway Materials Group, China National Materials Storage and Transportation, CTS International Logistics, China Logistics, and China National Packaging, the newly formed China Logistics Group directly owns 120 railway lines, 42 warehouses, and 4.95 million square meters of other storage facilities. It also has a fleet of three million vehicles across the world.1

Other examples of the broader trend of logistics players expanding their capacity include Cainiao buying a 15 percent stake in Air China Cargo last year and entering into long-term partnerships with LATAM Airlines Group and Atlas Air. Likewise, the express firm SF Holding bought a majority stake in Kerry Logistics, a $2.3 billion deal that would allow SF Holding to use Kerry Logistics as a platform for international business. SF Holding also added seven planes in 2021, bringing its total fleet size to 68 aircraft.2

Global companies have been looking to make bigger plays in the region too. The Danish shipping company Maersk bought LF Logistics, a Hong Kong-based contract logistics company, last December in a bid to shore up its omnichannel fulfillment capabilities in the Asia–Pacific region.3 Earlier in the year, Kuehne+Nagel acquired Apex, a leading air freight forwarder in Asia, to offer “customers a compelling proposition in the competitive Asian logistics industry, especially in e-commerce fulfillment, hi-tech and e-mobility.”4

3. The express-delivery sector is beset by intense price competition

Once the bright spark in the Chinese logistics landscape, the express market has not fared so well during the pandemic. While the express market has continued its meteoric growth, expanding by 30 percent each year since the pandemic started, intense price competition has caused the average revenue per item delivered via express channels to drop by between 12 and 27 percent last year. It now costs $1.40 on average to send a parcel, which is much less than in the United States, where the average delivery cost is $9.

Many express players saw their margins shrivel to less than 5 percent (Exhibit 3), with some falling into unprofitability. While regulators have stepped in and introduced price floors as a temporary respite, we expect greater consolidation in the near future. In a market landscape where many logistics players are embracing omnichannel integration, not having direct control over assets can prove disadvantageous. A Chinese logistics solutions provider that was built on an asset-light business model struggled to effectively control operations at its suppliers’ outlets. Operational problems ensued and the company started to lose market share in the express-delivery sector. By the end of the year, the company announced it was selling its express-delivery business to a global company looking to make inroads in China.

However, Chinese express players are suffering from 'price war'

Right now, the top eight express-delivery providers account for around 94 percent of the market share (Exhibit 4). ZTO Express has managed to hold on to its market lead by offering the lowest parcel unit prices and by having a network that reaches more than 98 percent of the country’s districts and counties.

The express-delivery sector in China is becoming more consolidated, with top express-players capturing an increasing share of the market.

The fierce price competition will probably continue to weaken the smaller players. We therefore see continued consolidation, with smaller logistics players being acquired by larger groups, such as domestic logistics players, international players, or e-commerce players looking to control their supply chains. If the international express market is any indication, greater consolidation could be more profitable for the players that remain. The top three companies in the international express-delivery market control around 90 percent of the market share and enjoy profit margins more than three times of those achieved by China’s domestic express providers.

4. Air-cargo demand is taking off, thanks to mass customization

Shifts in e-commerce patterns are fueling demand for air freight, an often underappreciated value driver in the logistics sector. Traditionally, e-commerce supply chains relied mostly on maritime shipping to transport products in bulk to destination countries in advance, before local express providers take over the final leg of the delivery to the end customer. This model is already—and will continue—shifting.

This shift is due to digital advances in e-commerce, which has empowered mass customization, especially in fast fashion. For example, Shein, one of China’s largest fast-fashion e-commerce retailers, uses data analytics to inform the production of a huge range of trendy apparel (150,000 separate items in 2020) at extremely low price points and small volumes. These items are then targeted and marketed to specific demographics around the world via social media. When customers buy a product, they get a sense that their purchase is personalized according to their specific preferences. While its manufacturing base is in China, Shein’s core markets are the United States, Europe, Australia, and the Middle East.

It’s more efficient to deliver such orders from the product supplier to the customer in what is termed the “direct line” model. This refers to transporting products in bulk via air freight to local postal companies in the final destination, empowering swift last-mile deliveries to the final customers. Before 2016, postal companies fulfilled the end-to-end deliveries of small parcels, which accounted for about 40 percent of China’s total outbound direct-to-customer market. But companies are increasingly turning to the direct-line delivery model. By being able to offer much lower prices than traditional express companies, e-commerce behemoths like Wish, Lazada, Shoppe, and Shein in China have catalyzed the prominence of the direct-line model.

Many Chinese companies including JD Logistics, Cainiao, SF Express, and YTO Express are actively growing their freighter fleets. This is a sign that the direct-line model is gradually replacing traditional postal and express delivery (Exhibit 5). Between 2016 and 2020, the demand for direct-line delivery has risen by 84 percent.

China outbound B2C market size by logistics mode

Tariffs in the European Union and the United Kingdom may dampen growth of the direct-line market especially for small-ticket items. Duties are now applied across all imports, and there is no longer a de minimis threshold. However, the United States—which is the largest recipient of China’s outbound e-commerce parcels—continues to have a high de minimis with no tariffs for goods below $800, and measures have been introduced to facilitate customs clearance. The new Universal Postal Union tariffs will cause many of China’s bilateral postal rates to rise, in turn hastening the shift from postal to the direct-line model. Furthermore, mass customization supports the supply chain logic of minimizing inventories.

As the direct-line model becomes more ubiquitous in e-commerce, we expect it to drive the growth of air-cargo demand in China and account for 33 percent of total outbound air cargo by 2025. Additionally, air cargo is also projected to increase from 1.3 million tons in 2020 to nearly 2.0 million tons by the middle of the decade. To cope with the startling surge in direct-line volumes, 15 additional freighter aircraft may need to be deployed from China every week.

5. Warehouse and omnichannel are the next frontiers of automation technology

Despite an abundance of labor at relatively low costs, China has one of the highest degrees of logistics automation, especially in e-commerce. But there is much potential that is still untapped in omnichannel integration and warehouse technology.

New consumption trends and expectations are raising new logistical challenges, such as the effective coordination and management of omnichannel fulfillment. Not only are logistics providers struggling to handle a vast range of SKUs, as shippers cater to the increasing diversity of customer preferences, they are also finding themselves with excessive inventory resulting from information silos between brands and channels. As online shopping normalizes, customers not only expect greater visibility but also the right to regret and return the products they buy, which means logistics providers have to shore up their reverse logistics capabilities.

As more retailers pursue the direct-line delivery model for international fulfillment, warehouse operations need updating. Digitizing the end-to-end delivery chain can also help ameliorate the financial reality of rising labor costs in China. Logistics companies operating in large cities face the additional challenge of limited real estate for large warehouses, which is controlled by local government. Investing in warehouse automation and other digitalization technologies could help them optimize the use of space and reduce unnecessary rental costs.

Two types of players can make the most impact in this space. The first are ecosystem platforms such as the Cainiao (which was spun off from Alibaba) and JD Logistics (which was launched by the Chinese e-tailer The second category includes pure logistics businesses such as Eternal Asia and Feima.

These players may invest in comprehensive transportation and warehouse management systems that leverage advanced-analytics capabilities to route orders intelligently and optimally. They could also enhance data collection and monitoring systems to provide more granular tracking of the stock levels across various channels in real time. Another area for development: the capability to process scattered orders, which are often small, more rapidly.

JD Logistics has invested heavily in warehouse automation. The company opened up an intelligent-logistics center in 2019 in China’s Guangdong Province that boasts a single-day processing capacity of 1.6 million orders, powered by a three-dimensional automation system that can organize more than 20 million units of medium-size goods at the same time.5

How should global investors, shippers, and logistics providers respond to these trends?

An awareness of the trends in the Chinese logistics landscape could help global investors, logistics providers, and shippers make more informed decisions regarding which areas to invest in, which Chinese market subsectors to enter, or how to plan for their supply chain.

Shippers. With China’s borders remaining highly constrained and belly capacity not returning in sufficient enough levels, it’ll be another tight year across supply chains. The risks of recurring COVID-19 outbreaks continue to threaten the supply of logistics services in air cargo, maritime shipping, and land-based deliveries. For shippers, diversifying suppliers and ports of export is a prudent solution. Some large shippers may consider expanding their ownership of logistics assets. We expect major e-commerce companies to buy air capacity and commit to long-term dedicated agreements for trucking.

Logistics providers. This will probably be another strong financial year, but one with significant operational challenges. Winners may be able to distinguish themselves by meeting their customers’ needs flexibly in times of constrained supply chains. Digitization and automation are critical, and logistics providers should double down their investments in these areas. We expect to see a rise in R&D investment into direct platforms with suppliers and with customers. While larger players may be able to manage this, smaller logistics players are at risk of being squeezed out. They might have to be extra entrepreneurial to seek out the financial backing they need (or the right kind of partnerships) to equip themselves with critical digital capabilities. Otherwise, they might find that the next best step would be to get their business ready for sale to clinch the best valuation.

Investors. 2022 presents a wide range of opportunities. For those that have previously bought logistics assets, 2022 could be a great year to sell to reap plump margins—many international and domestic logistics companies are on the lookout for consolidation opportunities in the market. There could also be select opportunities for investment. As mentioned earlier, smaller logistics players in the express market would likely be seeking financial support to digitalize their businesses.

The pandemic has ushered the Chinese logistics market into an interesting stage of its evolution. While the five trends outlined here take place within China’s borders, their implications are far-reaching and global. Whether it’s doubling down on omnichannel and warehouse innovation or reassessing their supply chain for direct-line deliveries, stakeholders familiar with these trends should be informed in their decision making as they look ahead in 2022.

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