SF Express, YTO, and the other China express delivery majors have been racing to go public. Faced with shrinking profits and mounting competitive threats, the dream of being the “FedEx of China” is quickly morphing into an arms race in capital and capabilities.

Here’s my take on what is going on and what to expect. But first two quick background points.

Point 1: Chinese express delivery is awesome. The market is huge, rapidly growing, and riding multiple China trends.

Chinese express delivery companies handled over 31 billion parcels in 2016. That was a greater volume than in the US and up from just 9 billion pieces in 2013. The volume is surging.

The revenues are also growing. Revenue in 2016 was 400B RMB, up from 30B RMB in 2006. YTO alone generated revenue of 25B RMB (2014).

It’s just a huge and rapidly growing market. This is quite logical when you think of the China trends fueling this. Express delivery benefits from rising consumer spending, increasing retail activity, big industrial production, continued urbanization, inland development, still strong GDP growth and, of course, surging e-commerce. It’s as good a macro story as you will see in China.

Within express delivery, private companies have been doing particularly well in the aggregate. In 2013, private Chinese courier companies accounted for two-thirds of the market by revenue and three-fourths by volume. For example, YTO delivered 2.1B packages in 2014 and has predicted growth of 50% per year through 2020.

So for all the talk about Alibaba, Tencent and the other Chinese Internet giants, the much-less-sexy express delivery business may be where the most predictable, long-term profits are.

Point 2: Unfortunately, the competitive situation is becoming increasingly difficult – and there are some daunting threats on the horizon.

Consider the following:

• There are likely upwards of 8,000 domestic competitors in express delivery in China today. And more are entering all the time, especially in intra-city delivery (i.e., deliveries within a single city).
• The cumulative market share of the top 4-5 express delivery companies has fallen from its previous 60-70% to less than 40-50%.
• Against this competitive picture, average prices have fallen +35% in the last 2-3 years (according to the State Post Bureau).
• At the same time, costs have been increasing, particularly labor which can be +40% of the cost structure.
• In cross-border delivery, the global giants (Fedex, DHL, TNT, UPS, etc.) are continuing to expand into China.

Overall, we see an increasingly difficult environment. There is increasing competition, falling prices, and rising costs – which is part of what is driving increasing capital requirements.

Plus, looming just on the horizon are some fairly daunting threats. For example, Lenovo has been rolling up some of the smaller delivery companies. Industrial and other Chinese giants (especially State-backed) have more than enough capital to enter this market.

And finally, there is Alibaba, JD and the Internet e-commerce giants. As e-commerce surges, they have been moving into logistics and delivery from a position of strength. Alibaba’s Cainiao (recently valued privately at $7.7B) now apparently has over 180,000 express delivery stations and 128 storage warehouses across China.

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That’s a bit of background. My goal with this article is to understand the recent acceleration by the market leaders in response to all this. Here’s my conclusion:

Faced with this situation, the market leaders are racing for inter-city market share and operating scale. First, a bit of competitive theory.

Keep in mind, most businesses have no real competitive advantages or barriers to entry. The leading companies do tend to get bigger and more efficient over time but they are never really protected from new entrants. And they are usually not particularly profitable, relative to capital. This very normal situation can be especially brutal in hyper-competitive China – as a trip to any electronics mart will show.

But in a small number of businesses, including express delivery, you can have powerful advantages that enable both long-term domination and profits (again relative to capital). You can see this type of domination in the financials of FedEx and UPS going back twenty years. There’s a reason why Warren Buffett owns lots of UPS.

So faced with the above market and competitive picture, my question is: Do China’s express delivery majors have a viable path to such entrenched dominance? Can they become like Fedex?

To answer this, it helps to view express delivery as three different businesses.

First, there is intra-city delivery, such as delivering packages from one office to another within, say, Shanghai. This is unbelievably competitive as pretty much anyone with a scooter can enter. Today, this business is a sea of private companies plus some lesser involvement by State-owned entities such as EMS. It is +50% of the overall market by volume and revenue. You can survive but you can’t really win here.

Second, there is international / cross-border delivery. This market is more or less equally split between private Chinese companies, State-owned entities and the international delivery giants (FedEx, UPS, etc.). This business does offer the type of competitive advantages we are looking for. Unfortunately, the international giants are the ones that have them.

And third, there is cross-regional / inter-city service (i.e., sending from one part of China to another). This is the great hope of the Chinese express delivery leaders. Because inter-city delivery appears to offer the strong advantages we want. And I think this is what the recent acceleration and race to go public is really about. The majors are racing after this opportunity, and it requires lots of capital.

The goal is to get to an operational scale (i.e., trucks, warehouses, distribution centers, IT systems) that enables offering rapid delivery to a national network of locations at prices others cannot match.

That last part is the finish line. That’s how you win. You offer national delivery at a price and speed your competitors can’t match.

But to achieve this, you have to be larger than the other players. It is only when they have a size advantage (in volume and fixed costs) that you can actually price lower than your rivals (i.e., it’s about economies of scale in the fixed costs of distribution relative to market size.). This is why the race for scale is so frantic. To win you don’t just need to be big. You need to be bigger than the other guys.

I argue the key to winning in Chinese express delivery is getting to superior scale (both in volume and in operations) in cross-regional (not intra-city) delivery.

At a minimum, this should result in some degree of protection from the increasing competition.

Ok. That was a bit of theory. I will go into more practical examples in the follow-up article. But I think this explains most of the actions we are seeing by China’s express delivery companies – including:

• The race to go public (mostly by backdoor listings) and to raise capital.
• The rapid build out of operational scale (warehouses, distribution centers, trucks, etc.).
• The big investments in IT, automation and other geographically integrating assets.
• The launch of their own airlines. This part is pretty interesting.
• The increasing focus on cross-border delivery within Asia (but not beyond).

I do think this is the best strategy and it has worked elsewhere. But China is different and, ultimately, this approach may not be enough, especially against the e-commerce giants.

Note: Part 2 on “Who Will Become the “FedEx of China” is here.

Cheers from Beijing, Jeff

Top photo by Jens Grabenstein, Creative Commons license with link here.

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I write, speak and consult about how to win (and not lose) in digital strategy and transformation.

I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.

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