American finance

Nightmare on Wall Street

Sep 15th 2008 | NEW YORK AND WASHINGTON,DC
From Economist.com

A weekend of high drama reshapes American finance

AP

EVEN by the standards of the worst financial crisis for at least a generation, the events of Sunday September 14th and the day before were extraordinary. The weekend began with hopes that a deal could be struck, with or without government backing, to save Lehman Brothers, America’s fourth-largest investment bank. Early Monday morning Lehman filed for Chapter 11 bankruptcy protection. It has more than $613 billion of debt.

Other vulnerable financial giants scrambled to sell themselves or raise enough capital to stave off a similar fate. Merrill Lynch, the third-biggest investment bank, sold itself to Bank of America (BofA), an erstwhile Lehman suitor, in a $50 billion all-stock deal. American International Group (AIG) brought forward a potentially life-saving overhaul and went cap-in-hand to the Federal Reserve. But its shares also slumped on Monday.

The situation remains fluid, and investors stampeded towards the relative safety of American Treasury bonds. Stockmarkets tumbled around the world (though some Asian bourses were closed) and the oil price plummeted to well under $100 a barrel. The dollar fell sharply, and the yield on two-year Treasury notes fell below 2% on hopes the Federal Reserve would cut interest rates at a scheduled meeting on Tuesday. American stock futures were deep in the red too. Spreads on risky credit, already elevated, widened further.

With these developments the crisis is entering a new and extremely dangerous phase. If Lehman's assets are dumped in a liquidation, prices of like assets on other firms' books will also have to be marked down, eroding their capital bases. The government's refusal to help with a bail-out of Lehman will strip many firms of the benefit of being thought too big to fail, raising their borrowing costs. Lehman’s demise highlights the industry’s inability, or unwillingness, to rescue the sick, even when the consequences of inaction are potentially dire.

The biggest worry is the effect on derivatives markets, particularly the giant one for credit-default swaps. Lehman is a top-ten counterparty in CDSs, holding contracts with a notional value of almost $800 billion. On Sunday, banks called in their derivatives traders to assess their exposures to Lehman and work on mitigating risks. The Securities and Exchange Commission, Lehman’s main regulator, said it is working with the bank to protect clients and trading partners and to “maintain orderly markets”.

Government officials believed they had persuaded a consortium of Wall Street firms to back a new vehicle that would take $40 billion-70 billion of dodgy assets off Lehman’s books, thereby facilitating a takeover of the remainder. But the deal died when the main suitors, BofA and Barclays, a British bank, walked away on Sunday afternoon. Both were unwilling to buy the firm, even shorn of the worst bits, without some sort of government backstop.

But Hank Paulson, the treasury secretary, decided to draw a line and refuse such help. After the Fed had bailed out Bear Stearns in March and the Treasury had taken over Fannie Mae and Freddie Mac last weekend, expectations were high that they would do the same for Lehman. And that was precisely the problem: it would have confirmed that the federal government stood behind all risk-taking in the financial system, creating moral hazard that would take years to undo and expanding taxpayers’ liability almost without limit. Conceivably, Congress could have denied Mr Paulson the money he needed even if he had been inclined to bail Lehman out.

This left Lehman with no option but to prepare for bankruptcy. Though the bank has access to a Fed lending facility, introduced after Bear’s takeover by JP Morgan Chase, the collapse of its share price left it unable to raise new equity and facing crippling downgrades from rating agencies. Moreover, rival firms that had continued to trade with it in recent weeks—at the urging of regulators—had begun to pull away in the past few days. The inability to find a buyer is a huge blow to Lehman’s 25,000 employees, who own a third of the company’s now-worthless stock; in such a difficult environment, most will struggle to find work at other financial firms. It also makes for an ignominious end to the career of Dick Fuld, Lehman’s boss since 1994, who until last year was viewed as one of Wall Street’s smartest managers.

Merrill’s rush to sell itself was motivated by fear that it might be next to be caught in the stampede. Despite selling a big dollop of its most rotten assets recently, the market continued to question its viability. Its shares fell by 36% last week, and hedge funds had started to move their business elsewhere. Its boss, John Thain, concluded that it needed to strike a deal before markets reopened. It approached several firms, including BofA and Morgan Stanley, but only BofA felt able to conduct the necessary due diligence in time.

Not only has Mr Thain managed to shelter his firm from the storm, but he has also secured a price well above its closing price last Friday, $29 per share compared with $17. How he managed that in such an ugly market is not yet clear. Ken Lewis, BofA’s boss, is no fan of investment banking, but he is a consummate opportunist, and he has coveted Merrill’s formidable retail brokerage. Still, the deal carries risks. It will be a logistical challenge, all the more so since BofA is in the middle of digesting Countrywide, a big mortgage lender. Commercial-bank takeovers of investment banks have a horrible history because of the stark cultural differences. And it is not clear if BofA has a clear picture of Merrill’s remaining troubled assets.

The takeover of Merrill leaves just two large independent investment banks in America, Morgan Stanley and Goldman Sachs. Both are in better shape than their erstwhile rivals. But this weekend’s events cast a shadow over the standalone model, with its reliance on leverage and skittish wholesale funding. Spreads on both banks' CDSs, which reflect investors views of the probability of default, soared on Monday.

Wall Street has company in its misery. Washington Mutual, a big thrift, is fighting for survival under a new boss. Even more worryingly, so is AIG, America’s largest insurer, thanks to a reckless foray into CDSs of mortgage-linked collateralised-debt obligations. Investors have fled, fearing the firm will need a lot more new capital than the $20 billion raised so far. Prompted by the weekend bloodletting, AIG brought forward to Monday a restructuring that was to have been unveiled on September 25th. This was expected to include the sale of its aircraft-leasing arm and other businesses. It is also reported to be seeking a $40 billion in bridge loan from the Fed, to be repaid once the sales go through, in the hope that this will attract new capital, possibly from private-equity firms.

With Lehman left dangling, official attention is now turning to putting more safeguards in place to soften the coming shock to markets and the economy. The first step has been to encourage Lehman’s counterparties to get together and try to net out as many contracts as possible. On Sunday the Fed also expanded the list of collateral it will accept for loans at its discount window, to include even equities; and dealers may lend any investment-grade security, not just triple-A rated, to the Fed in exchange for Treasury bonds.

Markets are also pricing in some possibility that the Fed will cut its short-term interest rate target from 2% when it meets for a regularly scheduled meeting on Tuesday. That would be an abrupt turnaround from August, when officials figured their next move would be to raise rates, not lower them.

In a sign of how bad things are, even straitened banks are stumping up cash to help the stabilisation efforts. On Sunday, a group of ten banks and securities firms set up a $70 billion loan facility that any of the founding members can tap if it finds itself short of cash.

Even if markets can be stabilised this week, the pain is far from over—and could yet spread. Worldwide credit-related losses by financial institutions now top $500 billion, of which only $350 billion of equity has been replenished. This $150 billion gap, leveraged 14.5 times (the average gearing for the industry), translates to a $2 trillion reduction in liquidity. Hence the severe shortage of credit and predictions of worse to come.

Indeed, most analysts think that the deleveraging still has far to go. Some question how much has taken place. Bianco Research notes that while the credit positions of the 20 largest banks have fallen by $300 billion, to $1.3 trillion, since the Fed started its special lending facilities, the same amount has been financed by the Fed itself through these windows. In other words, instead of deleveraging, the banks have just shifted a chunk of their risk to the central bank. As spectacular as this weekend was, more drama is on the way.

Monday, September 15, 2008

Safe Transactions with Infected PCs

A new tool assumes that a PC is loaded with malware--and protects transactions anyway.

By Erica Naone

Your computer has been breached by malicious hackers: it's completely loaded with malware and spyware. You're about to get online, connect to a financial institution, and make some transactions. Is there anything, at this point, that can keep your identity off the black market? SiteTrust, a tool released today by Waltham, MA, data-security company Verdasys, aims to protect users from fraud, even when their computers have been compromised.

Credit: Technology Review

"Malware is on the rise," says Verdasys chief technology officer Bill Ledingham. Many existing protection technologies don't work against all the malware that's out there, he says, partly because they're built to protect against known attacks. Users, he adds, are often inconsistent about employing antivirus software and keeping it updated, and even when they're not, some malware is sophisticated enough to get through anyway. "Our premise," Ledingham says, "is that, rather than trying to clean up the machines, assume the machine is already infected and focus on protecting the transaction that goes on between the consumer and the enterprise website."

The problem of malware on users' computers is "the number-one problem that the financial institutions are wrestling with today," says Forrester Research senior analyst Geoffrey Turner, an expert on online fraud. Financial institutions can take steps to secure the connections between their servers and their customers' PCs, Turner says; they can even ensure the security of the customer's Web browser. But they're stumped, he says, when it comes to the customer's operating system. Most successful attempts to steal computer users' identities, Turner says, involve using malware to capture their credentials or conduct transactions behind the scenes without their knowledge. "The challenge is, how do you secure the end-user computer?" he says. "Should you even, as a bank, be trying to do that?"

Verdasys thinks that the answer is yes. After licensing SiteTrust from Verdasys, a financial institution would provide it to users as a supplement to their existing antivirus software. Once SiteTrust is downloaded and installed, Ledingham says, it takes up less than a megabyte of disk space. When the user is connected to a protected site, SiteTrust consumes 1 to 2 percent of the computer's processing capacity. While the tool could work with multiple sites, the initial idea is that a customer would receive it for use with a specific website.

SiteTrust bypasses malware because it is essentially a rootkit--a program designed to bury itself deep in a user's operating system, where it can take fundamental control of most of the software running on the machine. The idea, Ledingham says, is that SiteTrust will burrow down to a lower level than any malware on the system. Verdasys has put a lot of research into ensuring that SiteTrust does just that, Ledingham says, but he acknowledges that if the tool becomes successful, online criminals will probably focus on finding ways to go even deeper. He says that Verdasys plans to keep improving the tool, hoping to stay a step ahead of attackers.

When the user types in the URL of a protected site, Ledingham says, SiteTrust steps in. Without changing the appearance of the user's screen, SiteTrust separates the secure transaction from whatever else might be going on in the browser by running a fresh version of the browser code as its own "process." (A process is the series of commands that the computer executes to run a program, and modern computers can run dozens of them at once.) SiteTrust then monitors this process to make sure that no other program tries to interfere with it. As the user interacts with the site, SiteTrust bypasses many of the vulnerabilities of the operating system, instead taking information from the user's keyboard, encrypting it immediately, and sending it to the website. SiteTrust currently runs on Windows machines and works with the Internet Explorer and Firefox browsers, but Ledingham says that the company is working on Linux, Mac, and Safari versions.

SiteTrust is a new application of the technology behind Verdasys's existing product, the Digital Guardian, which is meant to protect businesses against internal theft. The Digital Guardian also uses a rootkit, installed on every computer in an organization, that watches what users do with sensitive information and flags suspicious behavior. Ledingham notes that, although rootkits have caused controversy in the past, particularly when they were installed without users' knowledge, Verdasys has years of experience designing them so that they don't interfere with a computer's normal use. SiteTrust, Ledingham says, includes an uninstall option so that users can completely remove it if they choose, and it doesn't send any background information about the user to the protected site.

Turner says that he appreciates Verdasys's approach with SiteTrust--in particular, the way that the company has planned for the inevitability of online criminals' targeting the tool itself, lining up improvements to make that more difficult. He adds that the company's distribution model is important to getting SiteTrust to consumers. "People aren't aware that they need this level of protection on their own PC," Turner says. Customers aren't likely to look for additional protection unless encouraged to do so by financial institutions that they trust. Turner also notes that receiving the tool from a trusted institution should help counter consumers' general worries about rootkits.

SiteTrust is launching to six million customers of an undisclosed online broker in the near future. The company plans to make additional deals to protect other websites.

Enduring ideas: The GE–McKinsey nine-box matrix

Enduring ideas: The GE–McKinsey nine-box matrix

In one of a series of interactive presentations, McKinsey alumnus Kevin Coyne describes the GE–McKinsey nine-box matrix, a framework that offers a systematic approach for the multibusiness corporation to prioritize its investments among its business units.

September 2008---From Kckinsey Quarterly

With the rise of multibusiness enterprises in the 20th century, companies began to struggle with managing a number of business units profitably. In response, management thinkers developed frameworks to address this new complexity. One that arose in the early 1970s was the GE–McKinsey nine-box framework, following on the heels of the Boston Consulting Group’s well-known growth share matrix.

The nine-box matrix offers a systematic approach for the decentralized corporation to determine where best to invest its cash. Rather than rely on each business unit's projections of its future prospects, the company can judge a unit by two factors that will determine whether it's going to do well in the future: the attractiveness of the relevant industry and the unit’s competitive strength within that industry.

Placement of business units within the matrix provides an analytic map for managing them. With units above the diagonal, a company may pursue strategies of investment and growth; those along the diagonal may be candidates for selective investment; those below the diagonal might be best sold, liquidated, or run purely for cash. Sorting units into these three categories is an essential starting point for the analysis, but judgment is required to weigh the trade-offs involved. For example, a strong unit in a weak industry is in a very different situation than a weak unit in a highly attractive industry.

The nine-box matrix is the forerunner of a number of portfolio models, including MACS¹ and the portfolio of initiatives.² The criteria for assessing industry attractiveness and competitive strength have grown more sophisticated over the years. To this day, most large companies with a formal approach to modeling their businesses refer to the nine-box matrix or some descendant of it.

In one of a series of interactive presentations, McKinsey alumnus Kevin Coyne describes the GE–McKinsey nine-box matrix, a framework that offers a systematic approach for the multibusiness corporation to prioritize its investments among its business units. Click here to explore this framework in a new window.

Notes

¹Market-activated corporate strategy; see Frederick W. Gluck, Stephen P. Kaufman, A. Steven Walleck, Ken McLeod, and John Stuckey, “Thinking strategically,” mckinseyquarterly.com, June 2000.

²See Lowell L. Bryan, “Just-in-time strategy for a turbulent world,” mckinseyquarterly.com, June 2002.

Google's Decade

Google's Decade

Ten reasons why Google is still number one.

Friday, September 12, 2008

By David Vise

David A. Vise is a Pulitzer Prize winner and coauthor of The Google Story: Inside the Hottest Business, Media and Technology Success of Our Time, published by Delacorte Press (Updated edition 2008).

Credit: Technology Review

1998: Yahoo and others pass on the chance to buy new search technology developed at Stanford University for $500,000. Their rationale: "Search doesn't matter. Portals do."These rejections forced Sergey Brin and Larry Page to reluctantly take a leave of absence from Stanford (both wanted to become college professors, like their dads) to see if they could turn Google, their new search engine, into a business.

1999: A year later, Google garners $25 million from Sequoia Capital and Kleiner Perkins, even after Brin and Page insist that each venture-capital firm would only be allowed to invest half the money. This "divide and conquer" strategy leaves the denizens of Sand Hill Road to squabble with one another while Brin and Page retain control over their nascent enterprise. It also enables them to frustrate the moneymen by refusing to deface the most valuable piece of real estate on the Internet--the Google home page--by loading it up with ads, and by turning away numerous CEO candidates.

2000: Yahoo chooses Google to power searches on its portal, exposing the search engine to millions of users for the first time. With growth accelerating, Google benefits from the bursting of the technology bubble since this allows it to hire talented engineers for lower wages.

2001: Israeli entrepreneur Yossi Vardi persuades Brin and Page that Google can profit by drawing a thin blue line down the page, putting organic search results on the left, and placing small text-based ads on the right. Brin and Page previously resisted ads, fearing that they would cause people to lose confidence in the integrity of Google's search results. While at Stanford, they coauthored and delivered a paper called "The Evils of Advertising."

2002: Google cuts a deal with AOL to power search and syndicate ads, giving it access to 34 million America Online customers, and inks other similar pacts. Revenue increases 500 percent and profits skyrocket to nearly $100 million.

2003: Google launches an automated program to deliver contextually relevant text-based ads to hundreds of thousands of affiliated websites, creating a self-reinforcing network of support for the company and giving Internet publishers an easy way to profit by letting Google display ads on their pages. This strategy makes Google reminiscent of the three major television networks in their glory days: give away the programming for free, and profit from ads displayed on the network of affiliates.

2004/2005: Google raises billions of dollars in an unconventional initial public offering and a successful secondary offering, with Brin and Page retaining absolute control by owning shares with super-voting rights. In the process, they drive Wall Street professionals crazy by forcing investment bankers working on the deal to sign confidentiality agreements at every single meeting, rather than only once. With "Don't be evil" as the company motto, Brin is anointed as arbiter of good taste, deciding what does, and does not, fit. Beer and cigarette ads are out; wine ads are in.

2006: Google buys YouTube, giving it control of the world's most popular online video site. Google bets big on the future of video, paying $1.65 billion, even though YouTube has no sales. The view is that Google will capture the eyeballs and mindshare now and figure out how to make money later.

2007: Brin and Page both marry brainiacs at destination weddings, ensuring the pedigrees of their progeny. Brin and Page also reaffirm their private pact to work together for at least another decade atop Google. And with the stock price soaring, the duo breaks into the elite ranks of the top five on the Forbes 400 List of the Wealthiest Americans, with a net worth exceeding $15 billion each.

2008: Google's 10th birthday coincides with the 10th anniversary of the Justice Department's antitrust suit against Microsoft, which forced the giant to compete with one hand tied behind its back while Google raced ahead. Now Google is replacing Microsoft in the crosshairs of the Justice Department's antitrust division, due to the dominance of its online ads and search, and a proposed ad pact with Yahoo, its biggest competitor.

Tags: microsoft, Yahoo, Google, search, entrepreneurship, power

Online storage

Thanks for the memory

Sep 10th 2008
From Economist.com

A mathematical trick may allow people to scatter their computer files across the world's hard disks

WualaScatter brains

IF YOU have lots of unused storage space on your hard disk, then why not share it with others on the internet? The benefit could be distributed storage for your own files, making them available any time via the web, even if you are nowhere near your computer—indeed, even if your computer is switched off. That desideratum is what a Zurich-based firm called Caleido is aiming to provide, with a free online storage service known as Wuala that was recently introduced to the public.

Though the idea underlying it is simple, Wuala requires some nifty technology to make its distributed system work reliably. In particular, its developers, Dominik Grolimund and Luzius Meisser, have used a clever mathematical trick to compensate for the fact that the participating computers will come and go from the internet in an unpredictable way.

The challenge is how to minimise the number of copies of the same file that have to be distributed. Copying costs participants both storage space and bandwidth. Yet there have to be enough copies to ensure that there is at least one available most of the time. If, for example, each computer is online 25% of the time, then a quick calculation shows that you would have to copy each file to 100 different computers to ensure that 999,999 times out of a million there is at least one copy available when a user looks.

But copying every file a hundred times is hugely inefficient. Instead, Mr Grolimund and Mr Meisser plan to break each file into chunks, which can be scattered liberally around the hard disks of participating computers, and then to use a mathematical trick to reconstruct the original file from those chunks.

This trick, known as Reed-Solomon error correction, is employed routinely to interpret the data on DVDs, but it has not been used before in the volatile world of private computers on the internet. The first step is to convert the file (which is, regardless of what it represents, simply a long string of ones and zeros) into a mathematical function called a polynomial. This is done by splitting it into 100 fragments, which are smaller binary numbers. It is these numbers that are used to define the polynomial.

One of the characteristics of a polynomial is that a few numbers can nail it down precisely. If a simple polynomial is plotted out on a graph it forms a line. A straight line (the simplest type of polynomial) is defined by any two points on its length. A parabola can be defined by three points. The polynomials that Wuala generates can be defined by 100 points—though, because the polynomials used are not simple ones, these points are complex mathematical constructs, rather than straightforward numbers.

All you have to do now, therefore, is select a suitable number of points from along the polynomial (these need not be the original ones) and convert their values into the appropriate mathematical constructs. Scatter these around the host computers and, when someone wants to look at the file, he need recover only 100 of them to have enough data to reconstruct the file from scratch. To have 100 points available 999,999 times out of a million it turns out that you need to scatter a total of 600 of them around. That is an amount of data equivalent to six versions of the original file, rather than the 100 that would be needed to achieve the same level of reliability if whole files were being stored. Moreover, the system needs the computers linked to it to be available for only 17% of the time, rather than 25%, for this to apply.

Online storage is a growing market, especially for backing up data, where reliability is a big concern. Most commercial online-storage services use centralised servers. Although these are generally reliable, they do sometimes fail. And when they do, the results are embarrassing—as Amazon, an online shopping company, learnt on two occasions this year when the servers for its commercial data-storage system went down for several hours at a time.

Though some people may feel squeamish about scattering their data over hundreds of other computers (even though it will be encrypted), or storing unknown file fragments on their own, Mr Grolimund is adamant that Caleido has learnt from other “peer-to-peer” file-sharing systems, and that Wuala is built to handle concerns about the illegal distribution of copyrighted or “inappropriate” content. If he is right, Wuala may prove that, for online data storage, it is as good to give as it is to receive.

Growing pains for logistics outsourcers

Growing pains for logistics outsourcers

The customers’ demands are outpacing the logistics providers’ ability to meet them.

Bernard L. Bot and Carl-Stefan Neumann

May 2003---from the McKinsey Quarterly

From beginnings in the 1980s as humble additions to road, sea, and air carrier services, third-party logistics providers (3PLs) have built a $100 billion industry that plays an increasingly important role in the world economy. Determined to save money and to focus on core businesses, companies in the automotive, electronics, chemical, and fast-moving consumer goods sectors, among others, are outsourcing more and more of their warehousing, distribution, and other supply chain activities to these 3PLs. In Western Europe, they already handle more than a quarter of the total volume of shipments, while in the United States the figure isn't far behind. In the world as a whole, the market the 3PLs serve has grown at a compounded annual rate of more than 10 percent since the mid-1990s—a level of expansion that will probably be sustained (Exhibit 1).

Yet customers want more. They are starting, for example, to ask 3PLs to redesign their supply chains and to make those chains as efficient and inexpensive as possible. And as customers move from local to regional and then global scale, they want logistics specialists to serve them with consistent skills wherever they do business. Although the industry is at pains to respond, many logistics providers are hard-pressed to meet such demands.

Even as customers ask more of their 3PLs, they are beating down prices through canny contract negotiations that shrink profit margins and make returns on invested capital inadequate. The result is a business model increasingly under pressure precisely as related transportation businesses—freight forwarders, express integrators, contract manufacturers, and wholesale distributors—are encroaching on the 3PLs' territory.¹

Raising profitability in such an environment poses its own logistics challenge for the industry, since the customers' expectations have clearly outpaced the 3PLs' ability to respond. For the winners, catching up is likely to mean adopting a business model built on greater structural and technological savvy and, in many cases, greater consolidation. More specifically, the 3PLs must build regional and global scope by establishing themselves in geographies ahead of their customers. They will also have to achieve economies of scale by orchestrating ways for their customers to share warehouse and distribution facilities instead of bowing to demands for customized service. Doubling the number of spare parts delivered through a single distribution network, for example, could cut a 3PL's costs by up to 15 percent (Exhibit 2).

For this kind of multiuser approach to work without provoking nightmarish operational lapses, 3PLs will have to invest heavily in standardizing their IT systems interfaces. They will also have to hone their skills to design efficient supply chains and to pursue best practices in far-flung offices. And if their main customers—global industries—are going to be served efficiently, they will have to bulk up, fueling the continued consolidation of an industry that continues to be fragmented.

The world of the 3PLs

Logistics specialists have made their bread and butter by offering customers 15 to 20 percent savings on warehousing and transportation costs. In particular, 3PLs help clients reduce their capital spending (by eliminating assets such as trucks and warehouses), their working capital (by cutting inventories), and, especially, their personnel costs (through the 3PLs' more advantageous labor contracts).

More recently, the logistics companies, focusing on improving their customers' supply chains, have promised a 10 to 25 percent reduction in their customers' delivery cycle times by eliminating certain goods-storage steps and improving their information-management skills. Such efficiencies can boost sales because they help producers to respond more quickly to market trends and to reduce stock-out costs. In a recent worldwide survey of 50 large customers, we found that those using 3PLs to manage their warehouses moved goods in and out more than twice as quickly as those relying on in-house logistics departments. Logistics specialists also increasingly finance their customers' activities by taking ownership of inventories.

Another new wrinkle in the logistics game is the fact that many 3PL customers are changing the scale of their outsourcing. In the electronics and automotive industries, customers are moving from contracts for single localized services—a solitary warehouse in one country, say—to contracts for integrated services in several countries. Top logistics providers are following suit: Exel, for example, has a contract with Motorola to manage large parts of its supply chain to and from warehouses in Amsterdam, Chicago, Hong Kong, and Singapore. Given the importance of cross-border flows in these sectors, such contracts are likely to proliferate; in electronics, cross-border flows already represent 35 percent of total industry value.

Besides managing physical assets, leading logistics companies are using sophisticated IT to optimize the flow of information through the supply chain. In many industries, information-related logistics costs—lost sales, rebates, and inventory financing—surpass asset-related direct costs such as freight and warehousing. The impact of markdowns and lost sales in the apparel industry, for instance, means that information-related costs make up nearly 70 percent of total logistics costs (Exhibit 3); in toys and games, the figure is 60 percent. Moreover, the potential savings are frequently larger for information-related logistics costs than for asset-related ones, which in many cases have already been squeezed dry.

A tougher world for logistics providers

Still, logistics specialists are falling short in profitability. The average return on invested capital (including goodwill) for pure 3PL players—7 to 8 percent—has been below their weighted average cost of capital for years, so they have destroyed shareholder value. These disappointing returns can be explained only in part by overpayment for acquisitions and delays in capturing integration benefits. Margins, measured as earnings before interest, taxes, and amortization, have also declined, from about 5.3 percent in 1997 to 3.4 percent in 2002 (Exhibit 4).

Many of these economic woes can be traced to flawed contractual relationships. Customers specify requirements in detail, often parceling out pieces of the supply chain to different 3PLs and limiting their opportunities to differentiate themselves, since the division of responsibility prevents them from optimizing their operations. Essentially, customers buy commodity services largely on the basis of price and continue to design their supply chains in-house. In addition, the 3PLs' cost structures are transparent. About half of the industry's contracts are "open book"—so customers know what costs the 3PLs bear—and include contract-margin and cost-reduction commitments. With "closed-book" contracts, by contrast, customers get fixed, indexed prices for given volumes but don't see the 3PLs' actual costs. Customers can, however, usually make good estimates based on experience and benchmarks from in-house operations. Tire manufacturers, for instance, employ specialists capable of walking through a tire warehouse and estimating the cost of warehousing to within 1 or 2 percent of the best-practice level.

Another problem is the fact that logistics operators find it hard to cash in on good performance: customers demand more stringent performance levels at the end of contracts, which typically run from three to five years. In addition, low renewal rates of around 40 percent—prompted in part by disappointment over the quality of service—mean that 3PLs can get stuck with expensive warehouse capacity and freight purchase obligations. And because contracts abound with individual requirements, 3PLs have difficulty exploiting economies of scale. Instead of installing an industry best-practice IT system developed and improved over the course of many client contracts, for example, 3PLs must often build expensive customized systems or links into legacy logistics systems providing for limited or no economies of scale.

The contract-by-contract approach also harms operations. In the rush to move from one customer to the next, 3PLs often fail to benchmark and establish best practices, instead constantly reinventing the operational wheel. Within any given company, it isn't uncommon to find productivity differences of 50 to 75 percent among similar operations in the same industrial sector and even the same country. Furthermore, the industry's single-contract norm means that a logistics provider's business-development employees spend their time fixing problems rather than studying clients in depth and building mutual trust.

Building a leading logistics player

Our research suggests that logistics providers eager to establish more equitable customer relationships and to shore up their long-term business models might consider a strategy built on three related approaches: offering more value, creating structural scale advantages, and pursuing consolidation.

New sources of value for the customer

The micromanagement of contracts will go on until customers stop seeing 3PLs only as lower-cost alternatives to in-house logistics operations. To strike out in a new direction, 3PLs should first improve their supply-chain-design skills, focusing on industries with reducible asset- and information-related costs. The potential varies: bulk commodities, for example, largely involve transportation, whereas the more complicated and time-sensitive flow and storage of electronics and automotive parts offer greater scope for reducing customer costs. Companies in some industries regard the optimization of logistics as a core success factor and see little point in outsourcing the design of their supply chains. These kinds of companies are best ignored.

To get the most from logistics once an opportunity has been identified, 3PLs must master the specifics of the industry supply chain by analyzing supply-and-demand flows and matching them with the cost and performance (speed, reliability, flexibility) of various warehouse and distribution options. Savings can be had by managing a complex, labor-intensive, and fragmented supply base and by getting a grip on the suppliers' lead times. To do so, logistics managers need IT systems that make it easy to follow the flow of goods in the supply chain. Certain 3PLs have already developed relevant skills and systems. TNT Logistics, for instance, uses a software tool that makes it easier to see the inbound flow of parts in an automotive operation, thereby helping vehicle manufacturers to fine-tune production schedules up to the last moment.

Economies of scope offer 3PLs a chance to expand the range of their services to a degree that customers could never accomplish in-house. Integrated logistics and freight forwarding, for example, might be attractive to companies that prefer to deal with fewer transport and logistics providers. Exel has successfully introduced such a combination; 40 percent of its new business is generated by cross-selling freight-forwarding services. Integrating a freight forwarder with a logistics provider also offers advantages such as improved customs handling and a greater international presence.

But combining these two kinds of businesses isn't right for all companies in the industry. Freight-forwarding capabilities, for instance, have greater importance in some sectors than in others—a 3PL that focused on electronics would need these services more than one specializing in chemicals. Besides, many 3PLs are too small to acquire a freight forwarder, and integration can raise operational difficulties: a freight forwarder's business, based on trading, is light on assets and longer-term contractual risks; the operations of 3PLs, by contrast, require longer-term commitments as well as investments in assets.

Enhanced regional and global scope becomes more important to logistics providers as their customers expand around the world, because it helps providers offer consistent service and supply chain transparency. Unilever, for example, is looking to Exel to provide warehouse services in Brazil, Mexico, the United Kingdom, and the United States—all countries where it has built a presence. But at times, a 3PL will have no assets on the ground. It will then have to decide whether to find a local partner, to buy one, or to build from a standing start.

Structural scale advantages

New services are important, but they aren't enough to revitalize a 3PL's business model; some could be matched by competitors and, in certain cases, by customers. The 3PLs, to buttress their position, must build scale advantages that will be harder for competitors to duplicate. To that end, they can learn from leading network companies such as United Parcel Service. UPS has come to dominate the US parcels and express market by realizing scale benefits other operators can't copy. Logistics providers should seek scale advantages by striving to use the same warehouses and transportation assets to serve many customers, which will share in the savings. Logistics providers can offer these savings to encourage a move away from shorter-term, commodity-like contracts that are unlikely to be renewed. With every new customer, the system gains scale and appeal. The individual components of logistics contracts—warehousing, freight transport, local distribution, IT, the back office—provide many opportunities to leverage scale. Larger volumes enable 3PLs to consolidate and renegotiate freight purchases at better rates and to spread back-office and IT costs over a larger customer base.

Density too is a vital factor in the cost of local delivery: since route costs are fixed, doubling volumes can reduce the expense of delivering individual items by about 20 percent. Several logistics operators² have joined forces with CAT, formerly Renault's automotive-logistics branch, to operate a network serving a range of automotive customers for new vehicles and spare parts; at 48 logistics centers, they are stocked side by side and delivery is shared. Shared networks exist in other industries too. Exel's Tradeteam has consolidated deliveries to the UK drinks industry, for example, and TNT Newsfast has done the same for the UK publishing market.

The benefits of networks can be significant, but putting them in place will be hard. First, the 3PL will have the complicated task of linking several participants in one network. This challenge will involve standardizing and integrating various IT systems—for example, by installing middleware that links the IT systems of a 3PL with those of its customers and by aligning communications and product standards and operating procedures. Only then can the 3PL decide on the rules of the game in the joint network. Priorities must be set; which customer, say, takes precedence in the case of rush orders, and how are costs to be allocated? Finally, the 3PL will have to negotiate the way benefits will be shared and which company must shoulder the fixed network costs if, for instance, the system's volumes fall.

How more consolidation may help

Globally, the third-party logistics market is fragmented: Exel, the largest operator, has only about a 4 percent share. Although Exel is particularly strong in electronics, TNT Logistics in automotive products, and Hays Logistics in fast-moving consumer goods, no company has yet gained a leading European or North American, let alone global, position in these sectors. Mergers and acquisitions could help logistics providers improve their economics by combining volumes in some sectors and shedding activities in others. Such deals would also help providers meet the demands of their customers by filling geographic or capability gaps; some European logistics specialists, for example, have used acquisitions to enter the US market,³others to build freight-forwarding capabilities.

Mergers, however, offer limited economies of scale in the immediate term, for there are no established networks to be integrated; most of the business is configured client by client. Nonetheless, longer-term benefits of integration, such as the streamlining of back-office and IT activities, might be available. The potential for building multiclient user networks would improve if the merged companies had customers in the same sector; moreover, a 3PL's reputation might be enhanced if, after a merger, it could claim to serve all of a country's leading OEMs in a sector. Finally, the more concentration of this kind takes place, the more power 3PLs will have to resist onerous contracts.

Industry consolidation is already under way, and two clear groups have emerged. Companies in the first, which includes Exel, TNT Logistics, and the DHL Worldwide Express/Danzas logistics unit of DPWN,⁴ are developing strong regional (and often global) positions in a number of sectors. These positions make it possible to accumulate scope and skill advantages and to build denser networks. Companies in the first group are likely to shape the industry by virtue of their competitive customer offers and their financial flexibility to pursue mergers and acquisitions. Some freight forwarders have the same aspiration: Kuehne & Nagel International, for instance, bought USCO Logistics in the United States and completed a cross-equity holding with SembCorp Logistics in Asia.

Companies in this first group have already been consolidating. Exel as it currently stands was created through the merger of the Ocean Group and Exel, in February 2000. DPWN has made a string of acquisitions: Danzas in 1999, the European Transportation and Distribution division of Nedlloyd and ASG in 1999, and Air Express International (AEI) in 2000. This trend will probably continue as larger players buy up smaller ones that can't meet the industry's cost and service challenges but do fill geographic or capability gaps for the big players. Mergers of logistics providers present their own special hurdles—foremost among them the fact that in acquiring a 3PL, the purchaser is actually buying a pile of contracts (with change-of-ownership clauses), not a streamlined business. It must then find ways to integrate a multitude of administrative, transport, and warehousing systems, all built around customized solutions.

The second group of 3PLs comprises companies that have the potential to dominate at least one sector, often in a single region. TDG, for example, gets more than 60 percent of its revenue from the fast-moving consumer goods and retail sectors, and 75 percent of its total revenue comes from the United Kingdom. Microlog concentrates on small and midsize German companies in the automotive and industrial sectors. The challenge for such providers will be to maintain their lead in specific sectors and geographies and, given their limited focus, to grow. They will have to prove that local, specialized operations can meet the challenge of more global generalists that might try to leverage size and global skills to encroach on their territory.

The worldwide trend toward outsourcing noncore activities plays directly to the strengths of the logistics industry. But as the 3PLs have discovered, growth and healthy profitability don't necessarily go hand in hand. Logistics companies have much work to do if they are to rewrite a business model dulled by ever more demanding customers and bolder competitors.

Web-exclusive sidebar

Opportunities in Asia

More and more, customers are demanding that logistics companies follow them around the globe. That is particularly true in Asia, the source of so much of the world's manufacturing, especially in electronics. The region holds huge potential for logistics providers: annual sales of third-party logistics services are forecast to increase at three to four times Asia's overall rate of economic growth through 2010. At just over $1.1 trillion, Asia's logistics markets are probably half the size of those in Europe or the United States, but the potential savings—more than $140 billion a year—are far greater.

Three forces are firing up logistics demand in Asia: the spread of wealth beyond its major cities, the emergence of modern retailing, and global demand for its manufactured goods. Until now, Asia's major manufacturers and retailers preferred to set up in-house logistics chains rather than use local operators that offered neither efficiency nor an integrated, quality service.¹ Yet those manufacturers and retailers, hoping to free up capital for their core businesses, now want to outsource logistics.

Direct logistics costs—transporting, handling, and storing goods—are ripe for pruning in Asia, since they account for an average of 13.7 percent of total revenues, compared with an estimated 10.4 percent in Europe (exhibit). Closing only half of that efficiency gap could create a business opportunity worth $90 billion to $120 billion, an assessment based on industry cost structures in comparable economies, on pilot initiatives that have reduced costs by 40 to 60 percent, and on interviews with manufacturers to confirm their current and potential practices. Several companies reported that in Asia their stock spends an average of 30 days between manufacture and sale to consumers, but very little of that time is spent on store shelves; transportation, storage, and processing take up a full 27 days. The introduction of hub-and-spoke transport networks and of centralized dispatch functions is the most immediate step needed to reduce this lengthy period.

Improving the efficiency of logistics would also reduce stock obsolescence problems and missed sales—indirect, information-related costs that are 25 to 50 percent higher in Asia than in Europe, depending on the product. Goods that remain unsold and are then superceded by new models cost manufacturers, wholesalers, and retailers in Asia some 4 to 5 percent of their combined revenues. Sales lost when goods aren't in stock represent a further 5 to 7 percent hit to revenues. The more quickly and reliably stock is delivered, the less must be held on premises and the more likely it is that sales orders can be filled. A 15 percent improvement in the efficiency of logistics would cut indirect costs by $50 billion to $60 billion.

To capture these savings, logistics providers must first configure their vehicle fleets, containers, and warehouses to an industry's requirements and develop industry-tailored IT systems that could manage the flow of goods through those fleets, containers, and warehouses. Then the providers will have to learn how to use their customers' real-time inventory data in their IT systems. Even in Asia, it is no longer enough to compete on the cost or even the quality of basic freight and warehousing services, since their cost and quality are easy to replicate. The crying need is for logistics providers and their customers to build insights and loyalty around shared information. This need is especially strong in a region characterized by unreliable data sources, fragmented supply chains, bureaucratic information and payment systems, and uncertain regulation. Integrity of information is extremely valuable.

The attractive targets in Asia include electronics, fast-moving consumer goods, chemicals, automotive, and textiles because in these industries logistics accounts for a relatively high proportion of the value chain. Third-party providers are thought to be more fragmented and less efficient than those in Europe, so providers that made quick and lucrative inroads there will have a ready base of knowledge and some assurance of a profitable future role in Asia.

—Kaushik Das, Benoit Dumont, and Karsten Schween

Notes

Kaushik Das is a consultant in McKinsey's Singapore office; Benoit Dumont is a consultant in the Amsterdam office; Karsten Schween is a principal in the Munich office.

¹See the Quarterly Web exclusive "Moving goods in China."

About the Authors

Bernard Bot is a principal in McKinsey's Amsterdam office, and Carl-Stefan Neumann is a director in the Frankfurt office.

The authors wish to thank Steven Vossepoel and Jan Willem Breen for their contributions to this article.

Notes

¹For the purposes of this article, our definition of logistics excludes independent freight forwarding (the contracting of land, sea, or air transport for customers) and contract land, sea, and air transport services. Nonetheless, many of them are rapidly converging under the logistics umbrella.

²AutoLogic, TNT Logistics, and Wallenius Wilhelmsen Lines.

³TNT acquired CTI Logistx; Ocean (now Exel), Mark VII Transportation; and Deutsche Post World Net, AEI.

⁴Deutsche Post World Net.

Interview---From the Mckinsey Quaterly

A pioneer in Chinese globalization: An interview with CIMC's president

A company that has already disrupted the container business is moving into transportation equipment and services.

Martin Joerss and Henry Zhang

May 2008

About 20 years ago, China International Marine Containers (CIMC) was a small, little-known container manufacturer with just 59 employees. Since then, under the leadership of Mai Boliang, the company has become the industry’s global leader. It has succeeded thanks to an aggressive domestic and global M&A program, a successful human-resources approach that stresses the retention of local talent to run its overseas operations, and a relentless push to innovate and to disrupt the status quo.

CIMC is the world’s largest manufacturer of dry-cargo and refrigerated containers. The most important sea- and land-based logistics systems in Asia, Europe, and North America use its products, which range from regular containers to shipping equipment for energy, chemicals, and food. In 2007, the company had sales of more than 6.4 billion (45 billion renminbi), owned over 100 domestic and international subsidiaries, and employed nearly 60,000 people.

Mai Boliang, CIMC’s president, recently talked with McKinsey principals Martin Joerss and Henry Zhang in Boliang’s office, in Shenzhen, China.

Mai Boliang

Vital statistics

Born January 1959, in Zhaoqing, Guandong Province

Education

Graduated with BS in mechanical engineering in 1982 from South China University of Technology, in Guangzhou

Career highlights

China International Marine Containers (1982–present)

• Member of board of directors and president (1992–present)
• Acting general manager (1990–92)
• Vice general manager (1987–90)

Fast facts

• Executive director of China Container Industry Association (CCIA)
• Vice president of China Society of Economic Reform (CSER)
• Vice president of China Logistics Association (CLA)
• Received CCTV “Magnificent Ten of the Chinese Economy” award (2004)
• Ranked among top 25 most powerful businessmen in China by Fortune China (2005)

 

The Quarterly: What do you consider to be the drivers of CIMC’s success?

Mai Boliang: First of all, the reform and opening up of China. This enabled China’s economy and foreign trade to take off, and the sustained growth of foreign trade has made it possible for China to become a global container-manufacturing center.

A second reason for CIMC’s success was its ability to predict and promptly react to business megatrends. In 1990, I predicted that China would become the global center of container manufacturing, replacing South Korea, the world’s number-one dry-cargo-container manufacturer at the time. I based my prediction on how the growth of world trade, and China’s role in it, would spur demand for containers, as well as the pricing advantage we would have over any foreign player. I recognized this possibility earlier than my South Korean competitors and preempted them by establishing a manufacturing footprint along China’s coastal areas.

The company’s ownership structure has also contributed to our success. We have two majority shareholders—COSCO and China Merchants¹ This is an unusual arrangement among Chinese state-owned enterprises, which usually have just one parent. We have found that the dual-shareholding structure has given us more of an opportunity to pursue medium- to long-term strategies, and we can worry less about short-term performance.

The Quarterly: What was the greatest difficulty at the beginning?

Mai Boliang: We didn’t have much money, but we did have a very clear strategy, position, and objective back in 1990—to be the world’s leading company in container manufacturing. However, the board and shareholders would not give me funding, so I had to figure out a way to expand without money. I put a lot of effort into doing an initial public offering as soon as possible to raise funds; CIMC was listed in Shenzen in 1994.

The Quarterly: How did you carry out your expansion strategy when financial resources were insufficient?

Mai Boliang: We signed agreements with other manufacturing companies under which we operated their businesses, paid them lease fees for the opportunity, and pocketed whatever was left over. At the beginning, we focused on building dry-cargo containers—these were low in cost and had low entry barriers, technically speaking, but the business was also extremely competitive and margins were falling all the time. Using this model allowed us to operate with little cash-flow pressure and to build our business organically before beginning to consolidate the other domestic players through mergers and acquisitions.

From 1993, CIMC merged over ten container makers along China’s coast, including those in Qingdao, Dalian, Tianjin, Shanghai, Nantong, and Xinhui; there were about 40 domestic makers in China at the height of our domestic merger activity. As a result, we won a more than 20 percent market share in the dry-cargo-container market and disrupted South Korea’s dominance in the global industry. Among our advantages were our price per container—a few hundred dollars less than the Koreans charged—and our location, since China had a trade surplus, and shipping clients wanted to buy the containers at the locations where they could ship right away rather than moving the containers around.

The Quarterly: What happened next?

Mai Boliang: We only had a single product line—dry-cargo containers—and low technology. Under these circumstances, no one could say we were number one in the world. So we diversified into refrigerated containers, or “reefers.” The technical barriers were high, and the market was dominated by Japan, which had 95 percent of the reefer market with its aluminum containers. Germany, which produced stainless-steel reefers, had the minority share of the market. In 1995, we did a joint venture with Graaff, of Germany—the first of our international M&A efforts. By working with the Germans and gradually improving on their technology, CIMC made steel reefers the norm for the global market after eight years. That ended Japanese dominance in this field.

Later, we expanded into tank and collapsible containers, gradually becoming the company with the most comprehensive range of goods in the industry.

The Quarterly: Now that the company has secured a dominant position, what comes next for CIMC?

Mai Boliang: When our market share approached 55 percent, I felt that we had reached the ceiling to growth—it is unlikely that our container-manufacturing business will grow as quickly now. We have to identify new areas for growth. However, given CIMC’s own strengths and weaknesses and the highly competitive environment in the industry, we are certain of one thing: we cannot do container shipping or leasing. Moreover, we should especially avoid moving upstream to make steel, the raw material of containers.

We realized that CIMC’s core advantages lie in manufacturing in China—that is, in our ability to control manufacturing costs. Therefore, the company was repositioned to supply modern transportation equipment and services. This new positioning has greatly expanded the scope of our business and made it possible for us to produce road transportation vehicles, as well as tanks for use in the energy, chemical, and food industries. With this repositioning, we placed on our agenda the possibility of building trains and ships. In other words, we will look closely at manufacturing a variety of transportation equipment.

The Quarterly: What role has innovation played in CIMC’s global strategy?

Mai Boliang: Innovation has been essential to each of CIMC’s successes. Our slogan is learn, improve, and disrupt. CIMC is a latecomer in every field in which we are involved. There is only one way for the latecomers to catch up with and outpace the forerunners—to disrupt their practices—and only innovation can make the disruption possible.

Take the production of reefers. Aluminum reefers, a market dominated by the Japanese, used to be the industry standard. CIMC imported sandwich-foaming technology from Germany, improved the reefer production process, reduced capital inputs, and improved capacity and efficiency by leveraging automotive technology. Production volume was expanded 1.5 times with merely 20 percent of the original capital input. Productivity improved to nearly 5 minutes per container from the previous rate of over 20 minutes. Innovation by CIMC in the areas of labor and materials costs, technology, and engineering processes has enabled steel reefers—which are inexpensive to maintain, high strength, and corrosion proof—to completely replace Japanese aluminum reefers and upset the old order.

Let me tell you another story about our operational innovations. Chassis for one type of container used to be produced and supplied in the United States. Later, they were made in South Korea and shipped, partially assembled, to the United States for assembly. We are now producing them 100 percent in China. All spare parts and materials are sourced in China, and all products are completed here before they are finally shipped to the United States. All US factories producing chassis had no choice but to shut down because of the fundamental changes we made in their production. CIMC captured a dominant position in the North American market for this product in three years, with a 60 percent market share. If we had refused to change the operational model, it would have been hard to exploit China’s advantages, and CIMC would not enjoy the market position it has now.

The Quarterly: CIMC has acquired quite a few overseas enterprises in recent years. Would you share with us your experience in integrating these companies?

Mai Boliang: Global competition is transforming the world into a single economic community, in which production activities are integrated and all resources are optimized globally. When we buy a company, we integrate it with this megatrend in mind. We see all our operating units as part of a single CIMC, and we share the same vision across those units. We must have a common understanding and consensus, so when we buy a company, we prefer to use one brand—CIMC.

At the operational level, our teams around the world must align themselves with the corporate business strategy. For example, everyone acknowledges that the Chinese team has a competitive edge in costs and manufacturing, while our overseas teams have a competitive edge in technology, management, and marketing. This common understanding is the basis for our work after we integrate other companies.

The Quarterly: What have you done to make the acquired companies feel a part of CIMC?

Mai Boliang: Under the rubric of One CIMC and One Shared Vision, we launched two initiatives—China–US interaction and China–Europe interaction—that brought overseas teams to China to improve communication and to develop more effective interactions. When overseas teams see what we mean by sincere cooperation, sharing competitive advantage, and mutual growth, why wouldn’t they believe that One CIMC will help everyone? In return, Chinese engineers were sent to Europe to get first-hand information about its markets and to conduct research and development. CIMC Europe has also sent people here to help with product quality control.

This has quickly and significantly improved our competitiveness in Europe. The acquired companies, now called European teams, were not comfortable with providing standard products, since their pricing was not competitive. Now they can leverage CIMC’s labor cost advantage, so they have full confidence in their ability to capture 50 percent of the European market for standard products. With the newly improved confidence and the ability to capture a bigger market share, why wouldn’t Europeans embrace the CIMC identity?

The Quarterly: How does CIMC meet the demand for global management talent?

Mai Boliang: The CIMC staff is a global staff. There is a general belief among Chinese executives that whenever a foreign company is acquired, Chinese executives have to be sent to manage it. I don’t think a Chinese team has to be assigned to Europe to manage companies acquired there. Many Chinese companies have failed in their overseas ventures because of this mind-set.

It would take three years, at least, for a Chinese team to get oriented to and acquainted with a foreign territory. How can that be efficient and profitable? In Europe, why don’t we simply hire Europeans? In fact, the optimization of global resources also includes the optimization of talent. After CIMC acquired Burg Industries, in Europe, someone at CIMC asked me whom we would send to Europe. I replied that we should look to the Europeans for our talent. Through Burg, we acquired 1,600 staff members in Europe. They are all CIMC people. Our European management team, which understands the local economy, market, and human environment, has managed this company well. Is there any need to send anyone from China there?

Indeed, we treat our European employees as core CIMC staff. Whatever I can offer is offered to them, including bonuses, stock options, and stocks. We provide the Europeans with as much as—or even more than—what they used to have from their previous, European employers. Of course, I have to tie their compensation to performance measured with key performance indicators.

It has been over four years since CIMC acquired its first foreign company. Every one we acquired has successfully survived the integration and is doing well.

The Quarterly: What are the biggest challenges facing the company?

Mai Boliang: Although we use as much local talent as we can, we still have a talent-development problem. CIMC operates in broader geographies, on a larger scale, and in more diversified fields than it did in the past, and that poses more severe challenges. Talent developed in our conventional Chinese manufacturing setting—just emphasizing the improvement of technical skills—will find it hard to deal with the new situations demanded by our increasingly sophisticated global context. For example, we find that the starting point of Chinese staff members who are developed internally, often from the shop floor, is relatively low and that it takes them longer than better-educated people to reach the point we think is sufficient for work at an international level.

Another challenge is how to capture the mainstream market for semitrailers, which CIMC began to manufacture for the first time in 2002, in Europe and the United States. We built our manufacturing base, added capacity through M&A in China, and later continued to expand our production and service base in the US market. For example, we set up a US subsidiary, Vanguard National Trailer, and later bought HPA Monon, a semitrailer and chassis manufacturer in the state of Indiana. Now CIMC is one of the largest companies in the world in terms of annual sales of all types of semitrailers. Still, the real challenge for me is how this business can gain recognition in mainstream markets and from mainstream customers and how CIMC’s design, technology, and engineering processes can shape the standards and the changing trends in this industry globally. 

About the Authors

Martin Joerss is a principal in McKinsey’s Beijing office, and Henry Zhang is a principal in the Hong Kong office.

Notes

¹China Ocean Shipping (Group) Company (COSCO), a $17 billion corporation, specializes in shipping and modern logistics and also serves as a shipping agency by providing services in freight forwarding, building and repairing ships, and operating terminals. The Hong Kong–based China Merchants is the major investor and operator of transportation infrastructure in the mainland and Hong Kong. It ranks among the world’s top three public port operators, with total assets of $14.6 billion and total assets under management of nearly $131 billion.