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LOGISTICS IN THE RETAIL MARKET IN HK Keith Bartlett Business Process Director Food, Electronics & General Merchandise Division A.S. Watson Good morning / afternoon. My name is Keith Bartlett, and I have been involved with Distribution and Supply Chain Management for the A.S. Watson group in HK for over 13 years – primarily for ParknShop and Fortress. I’d like to talk on logistics in the retail area in HK. One thing that has surprised me in HK is the huge gap in the standards of Logistics between the export area and domestic distribution. When it comes to exporting goods, HK has some of the finest infrastructure in the world. Our airport and our ports are world class. The terminals are containerized and are run with state-of-the art software. HK is a leader in this field. Hutchison, my parent company is a major global player. Internal distribution, in comparison, is a long way behind. In this field, HK is second or third rate. Few warehouse are automated, and many lack even basic IT systems. Outer case bar-coding is hardly used; bar-code scanning is unknown. Other countries and their suppliers are now busily developing RFID identification chips on pallets and outer case barcodes, but nobody distributing within HK is close to adopting this technology. In physical terms, there is still a reliance on manual labour in HK: all of the Rice is loaded and unloaded onto trucks by hand. It is still common to see frozen meat being carted around in open trucks with no temperature control. Why is there such a gap between the level of development in the export logistics area and internal distribution? There are 3 reasons for this – all interconnected. The cost of land is the first, and the backward nature of the retail industry is the second, but government policy is also a major factor. The cost of land is the big issue. Most warehouses are in high-rise facilities with inadequate loading docks and cargo lifts. These might be acceptable as go-downs for storing goods, but are inefficient as distribution centers. High development costs also means that the most of the shops in HK are located in buildings which were not designed to handle goods efficiently. Very few have a loading dock, and many are in basements or above ground rather than street level. Land costs have made distribution activities difficult to operate and difficult to modernize in HK. A second reason for the late development of distribution in HK is the backward nature of its customer base – the retail industry. A sophisticated distribution industry will not develop unless its customer base also modernizes. This process has only just started in HK. Most sections of the retail trade are highly fragmented with a large family-run independent sector. The wet markets still account for 50% of the home consumption of food, and the modernization of this part of the trade has hardly begun. In terms of policy, the government has not encouraged the modernization of either the retail trade or the distribution industry. Wet markets remain a government-run and subsidized area. In terms of logistics, the government has provided land and other forms of infrastructure support for shipping terminal and aviation, but not for local distribution needs. Until recently, the industrial land policy specifically excluded distribution activity from the trade parks. Our competitor, Wellcome, was only able to get a warehouse site in the Junk Bay park by incorporating a high proportion of production facilities. This policy has now relaxed, and logistics is recognized as vital industry for HK. It is also fair to say that domestic distribution has sometimes receives spinoff benefits from the developments at Kwai Chung. However, the terminals and airport seem to dominate attention. It’s easy to see why. Outbound logistics are seen as a growth engine for the economy. Internal logistics are seen as a domestic issue. I have even heard it argued that we should not become too efficient in this area because it would create unemployment. For the impact of government policy on domestic distribution we need to look both sides of the border. The policies of the Chinese government are just as important as local regulation. Domestic distribution is HK is a small market, insolated from the larger Chinese market by a series of barriers that prevent cross-border consolidation. More about this later, but it is clear that outbound logistics in HK operates on a vast scale serving the whole of the Pearl River Delta. Domestic distribution operates on a very local basis. It is not possible to have one warehouse serving retail stores on both sides of the border and for this reason, local logistics we cannot leverage the economies of scale achieved in industries. Nevertheless, in the last 15 years there has been progress in many areas. ParknShop provides an interesting case study. I’m sure you all know ParknShop, but for the record, ParknShop is the largest retailer in HK. It accounts for over 40% of the packaged food market. In terms of the wider shopping basket, including fresh foods, ParknShop has a 20% share. In terms of goods being moved along the road in HK, PNS carries the equivalent of 250,000 containers per year. This would make ParknShop the biggest distributor of goods within HK. As late as 1990, ParknShop was operating all its distribution activities from a single high-rise facility in Fo Tan. For its time, the old warehouse – seen here in cross-section – was highly efficient. There were 6 floors, each with five-pallet high bay racking, narrow aisles and man-up picking. The warehouse was designed to handle 25,000 cases per day, but by 1990 was regularly pushing through over 50,000 cases, and at seasonal peaks could actually achieve 100,000 cases. This was highly challenging, because the warehouse has only 6 docks for receiving and 6 docks for loading and only limited consolidation space. A breakdown in just one cargo lift, or a problem on one floor could result in the whole warehouse grinding to a halt. Delivery to store was carried out in a very traditional manner. Goods were being shipped in trucks, and were being hand-loaded at every stage in the process. This was highly inefficient. The first stage in ParknShop’s modernization was to use roll-cages and tail-lifts on the trucks. This allowed goods to be sent to the stores without double-handling. Here, for example, you can see the goods being picked in the warehouse into roll cages. The cages can be wheeled across a dock leveler into the truck. When the truck reaches the store, the tail gate can be used to lower the roll case to the road, where it can then be rolled into the store. This represented a big gain in efficiency, however, there were still several stores in buildings reached by steps where hand-loading was still necessary. In 1992 ParknShop invested $200m in a purpose built facility for fresh foods at Sheng Shui. The cost of land meant that this also had to be a multi-floor facility. There were separate floors for frozen and chilled. Central processing facilities were included here – primarily fruit and vegetable packing and meat packing. The main feature for this warehouse was the enclosed dock, which meant that temperature –controlled goods could be loaded without breaking the cold chain. For its time, the most advanced building of its type in HK. Also, in 1992, ParknShop expanded the ambient distribution capacity and rented 200,000 sq ft of space in the then new HIDC facility in Kwai Chung. This building, like ATL, was developed to service the terminals and handle consolidation for outbound logistics. However, the quality of the facilities attracted many domestic logistics operators. Wellcome moved to ATL and ParknShop took space at HIDC, taking advantage of the infrastructure developed for the terminals. Many of our larger suppliers also took space in these facilities. The domestic distribution area, as I said, received many spin-off benefits from the terminals, especially a muchimproved road network. ParknShop maintained the Fo Tan facility for slower-moving goods, and used the space at HIDC for fast-moving goods. The space, seen here from a vertical plan, was highly attractive for this purpose. All on one level, this space has 22 docks on both sides – 44 in total. This means that goods can be received and loaded rapidly. This distribution facility is the physical equivalent of a broadband connection for the shops. It can handle 150,000 cases per day without breaking into a sweat. After 1995 ParknShop moved into the superstore business, and the operation of big store formats placed many demands on the distribution network. For a start, the range of products served by the warehouse had to increase from under 10,000 to over 40,000. The total volumes increased by a factor of 2 – 3 times over a short period of time. Fresh foods were also added to the stores. Parknshop responded to this challenge in 2 ways. The first was to add some dedicated facilities for fresh foods. A fruit and vegetable section was added to HIDC in 2002. A pig cutting facility was added to the Sheung Shui DC, and this can now handle up to 1000 pigs a night. 3 laboratories were added to ensure the safety of the food. More recently, we set up a 10,000 sq ft facility in Ap Lei Chau for the distribution of live fish – both freshwater and seawater. No other retailer in the world has to distribute live fish or move Chinese vegetables and fresh meat to stores as quickly as ParknShop. Local customers demand freshness, which means that we have to handle fresh foods in the fastest possible way. The second response to the challenge was to improve the supply chain. Although ParknShop had a fair degree of efficiency, the supplier base was poorly developed and fragmented. In 1995 our warehouses held 4 weeks worth of stock, even though most of our supplier base was local. The major suppliers, such as Coca Cola, Vita, Watsons Water and San Miguel all delivered on different size pallets. We counted 14 different pallet sizes in our warehouse, only a few of which would fit the racking. Most suppliers hand-loaded onto our docks, and because the process was so time-consuming, the average waiting time outside our warehouse was a 4 hours. None of the suppliers were on a just-in-time basis, and most were giving us lead times of one or two days. This was clearly sub-optimal, especially given that most of our suppliers were delivering from go-downs which were les than an hour away by road. Parknshop took the view that our distribution centers did not need to hold more than a one day’s stock of product from a local supplier. In terms of modernizing our supplier base, we worked closely with the Supply Chain Management Board of the HK Article Numbering Association. In partnership with the other major retailers, we asked all our suppliers to deliver using standard pallets. We then introduced a pallet pool in HK, so that pallets could be hired and exchanged by the suppliers and retailers. This eliminated the need for manual unloading at the docks. Parknshop went a stage further, and asked key suppliers to deliver 7 days a week on a just-intime basis. In return, these suppliers were given a fast track access to the docks. Their trucks could now shuttle back and make 5 or 6 deliveries a day instead of just one or two. Wherever possible, cross-docking was introduced for local suppliers. The Parknshop warehouse holds no stock at all of cross-dock items. They are delivered by suppliers to the warehouse for immediate picking and delivery to stores. This process is now virtually complete. As a result, Parknshop managed to reduce the inventory from local suppliers from 4 weeks to less than 2 days. The space saved in the warehouse was used to handle a bigger range of products from overseas and from Mainland China. This provided the superstores with the additional products that they needed without having to increase the depot space. In fact if you compare ParknShop now with 1992 we have a vast increase in range and four times the volumes through the warehouse, and yet the distribution space is the same as it was in 1992. As a result, we have been able to give more choice and variety to our customers at a lower cost. Even so, ParknShop is not operating under ideal conditions in HK. Compare our operation with that of similar sized operation in Thailand. ParknShop and Lotus Tesco both distribute similar volumes of product. But Tesco operates from one big warehouse, and has surrounding parking space for hundreds of suppliers. ParknShop has to work from 6 different facilities divided into many storeys or chambers. Tesco would distribute goods in 40 ft trailers to their stores. In HK, hardly any stores could take a delivery from such a large truck. A very different operation. Indeed, compared to Thailand or Mainland China, the cost profile of distribution is very different. In other SE Asia countries, where land is cheap, the highest cost element in domestic distribution is trucking costs. This can account for 50-60% of the total. Warehouse costs are cheap because of cheap land, and labour is often inexpensive. In HK, the geography is small and the rents are high. As a result, trucking is a relatively cheap cost, at around one third of the total. Warehouse costs and warehouse labour are proportionately high, at around one third each. This cost profile means that HK distributors need to be efficient at stock and warehouse management. The actual situation is very patchy. Of the 10 biggest retailers in the fast moving consumer goods industry, less than half have so far established cross-docking. Automatic bar-code scanning of outer cases, common in western countries, is almost unknown in HK. Radio frequency warehouse systems, standard elsewhere, are equally rare. Some retailers have warehouse operations that have hardly advanced in 20 years. I can speak for Fortress, another part of our group, which until last year did not have a warehouse with computer controlled stock management. The warehouse staff had to remember where the goods were located, or keep their own notes. I’m happy to say that this now changed, and Fortress has leap-frogged to a state-of the art warehouse system using scanning and radio frequency. Of the supplier base, there are a dozen major local manufactures or suppliers and 3 or 4 local distributors which are centers of excellence. Outside of these, the majority of suppliers rely on traditional warehouse practice and stock management. Most warehouse operations are highly labour intensive. The rice trade, as I mentioned earlier, is still conducted on an almost manual basis and the industry is highly resistant to modernization. For the retail trade, the major impact is in terms of stock continuity. Few suppliers are able to control their warehouse costs without impact on service levels and out of stocks. The way that most suppliers have reduced costs is not by modernization within HK but by shifting the centre of their operations northwards across the border. Increasingly, much of the supplier base for HK is located in the MAINLAND CHINA. Suppliers have moved their production to Mainland China, and in most cases hold most of their stock across the border and feed into distribution centers in HK for the final delivery. Cross-border transport is still not easy. The cost of trucking goods over the border from Mainland China is has been coming down but is still very high, mainly because of licenses. Even with the border open 24 hours, the FEHD does not allow overnight clearance for fresh products which require testing or screening. Most of the fresh foods, therefore, which require the quickest handling, are still barred from 24 hour crossing. Most suppliers hold goods across the border, but this does not eliminate the need for distribution centers in HK. Bulk cargoes can cross the border relatively easily compared to mixed loads of products for multi-store deliveries. If this were not the case, most warehouse operators in HK would immediately move their operations to Mainland China. ParknShop has a warehouse in Shenzhen serving the stores in S China, but goods from that warehouse cannot be shipped directly to HK. This is a case of one country, two distribution networks. Export licences, commodity certificates and hygiene inspections means that the free access of goods across the border is a long way from reality. Like most operators, we cannot operate both sides of the border with a single distribution network, and cannot benefit from the economies of scale offered by the Pearl River Delta. Most of the red tape is on the Mainland China side. Exports to HK are often controlled by stateappointed agencies or monopolies, and this is reflected in the cost that people in HK have to pay. Pork, for example, sells for half the cost in Shenzhen than in Sheung Shui even though it might come from the same farm. We can import chilled pork from any country in the world, except from Mainland China. The pigs are only allowed across live. These type of barriers not only add huge costs to the food bills for consumers, but stop the implementation of efficient logistics in many areas of the food chain. There are state-of- the-art suppliers just across the border, but we are not allowed to buy from them. Where these barriers have come down, the results have been dramatic. 10 years ago, the only source of quality apples for HK was from Japan or America. This has now changed. Mainland China has had huge inward investment in these areas, and direct supply to HK is possible. Hence, a Fuji apple that cost $12 in 1990 can now be bought for under $2. An electric fan that cost $250 now costs a quarter of that price. In 1991 the cheapest toilet roll in the market sold for $2 and came from Thailand or Malaysia. PNS has recently been selling Toilet rolls from the MAINLAND CHINA for under 70 cents. It is not just cheaper production that drives the lower cost. The efficient logistics and supply chain is equally important. Wherever the industry can bring in full containers of stock from Mainland China without monopoly issues, or middlemen, the costs of distribution tumble. If a single distribution network could be established, the impact would be even more dramatic. To conclude, retail logistics in HK has improved significantly in the last ten years, but there is much more to do. ParknShop has been instrumental in modernizing logistics in many areas. Supply Chain Management techniques have made a major contribution to efficiency. Yet the domestic logistics area remains undeveloped and is a long way behind the level of sophistication in the export logistics area. High rental costs and lack of land is a severe pressure on the industry. The retail trade has not modernized in many areas and livelihood issues make it unlikely that this will happen quickly. The border with the Mainland China means that logistics operators in HK are confined to the small domestic market and cannot achieve economies of scale with Southern China. HK has world-class air and sea terminals, but the logistics area within HK is a poor cousin. Will the market become more open? Will there be freer movement of goods, and the possibility of an efficient and combined distribution network across the whole of the Pearl River Delta? Everybody knows it will all happen one day, but nobody exactly knows when.