Fedex moving forward on South China Hub

UNCLAS SECTION 01 OF 03 GUANGZHOU 000206

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TAGS: EAIR ECON EINV ETRD CH
SUBJECT: Fedex moving forward on South China Hub

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1. (SBU) Summary. Fedex is moving strongly forward on both of its
China hubs: one in Hangzhou for domestic operations and the other in
Guangzhou to serve as its Asia Pacific Headquarters and
international hub. A key draw for Guangzhou officials is the proven
ability Fedex has demonstrated to attract millions of dollars of new
high-tech multinational investment. Fedex's hubs will accelerate
China's logistical market growth and hasten Guangdong's transition
to a high-tech market. Challenges remain in the new postal and
transportation laws (the former limits shipments of under 150 grams
to the post office, while the latter is a challenge to what
constitutes express delivery service); these limit Fedex's ability
to provide complete services. End Summary.

Hub Opening in 2008
--------------


2. (SBU) Fedex General Manager Alex Yim, Fedex South China's
Regional Manager Robert Chu, and Fedex Sales Manager Barry Feng
outlined for visiting USDOC General Counsel John Sullivan, the
Consul General and an Embassy/consulate team Fedex's China business
development plan and benchmarks leading up to 2012, the scheduled
completion data of Fedex's new Guangzhou hub. After completing
several business studies, Fedex realized in 2004 that its current
hub in Subic Bay, Philippines, would be inadequate to handle future
package flows past 2012. Drawn by China's rapid economic
development, Fedex decided to build its Asia-Pacific hub at
Guangzhou's new Baiyun airport. The Guangzhou hub is expected to
serve seventeen major cities in the Asia-Pacific region, including
Tokyo, Los Angeles, Sydney, and Singapore as well as support a
second hub in Hangzhou, which will serve China's domestic market.


3. (SBU) China has agreed to a number of incentives Fedex had
sought, including a several year exemption from business and income
taxes, discounts on certain aviation fees as well as two critical
concessions: self-handling rights (a first for a foreign express
mail company in China) and freedom of transshipments (meaning
packages can transship Guangzhou with no Customs interference). The
Guangzhou Construction Bureau will build all necessary
infrastructure.


4. (SBU) The hub will open for business in 2008 with a thirty year
lease that can be extended to fifty years covering all costs. With
63 hectares (156 acres) Fedex is confident that the site can grow
with its needs. The company plans to begin with 1,000 employees and
is spending USD 250 million to bring the operation to reality. As
part of the deal, the Guangzhou government relocated 1,250 families,
building them a new village and providing compensation. Fedex meets
with the villagers every two weeks, primarily to ensure that the
village numbers do not suddenly inflate, increasing the compensation
bill.

A Proven Investment Multiplier
--------------


5. (SBU) A key sales point for Guangzhou and Guangdong is the
proven benefit that a new Fedex hub will generate: millions of
dollars of investment from high-tech multinational corporations
coming as a result of access to efficient logistical connections
worldwide. Fedex has spent time on educating officials on the value
of its hub project. Both Fedex and its governmental counterparts
see the new hub as accelerating the PRD business transition to
high-tech industries and moving low-tech, labor intensive industries
inland. Yim pointed out that the National Development and Reform
Commission (NDRC) is looking to expedite the whole industrial
process, enabling a quicker return on investments. According to
Yim, Fedex's China competitors take an average of 28 days to move a
package, while Fedex would take no more than three. He gave the
example of shipping I-PODS from Apple OEM supplier Foxconn, based in
Shenzhen. Fedex currently ships 250,000 pieces annually and expects
to reach 300,000 by the end of 2007. Fedex delivers the I-PODS to
their destination within two days of pickup, accelerating the entire
manufacturing and logistics process.

Problems and Challenges
--------------


6. (SBU) When asked about possible problems and issues of
transparency by General Counsel Sullivan, Fedex officials responded

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that the Guangdong government was progressive in its response to
change but the company still faced hurdles with rules and
regulations not always being transparent. Chu attributed the
increased openness in Guangzhou and Guangdong to the influence of
Hong Kong. As a result, officials are comparatively easier to talk
with and their reaction time is quicker. Chu and Yim gave the local
Party Secretary high marks for being action oriented and credited
him with moving the process along. The Fedex officials stated that
they were generally pleased with the Civil Aviation Administration
of China (CAAC) as the agency seemed to be driven by business and
practical reality, in part due to influence from the U.S. Federal
Aviation Administration (FAA) and the need to move people and
products.


7. (SBU) Yim and Chu both highlighted the problems Fedex faces due
to the gap between central government policy and local government
practices. In general, managing the Fedex-China relationship is a
balancing act; while Fedex takes a business view, its Chinese
official counterparts often do not. Yim said that Fedex has learned
that it needs to develop relationships with each official with whom
it deals, have careful planning before embarking on negotiations, be
willing to compromise but be firm on its critical issues, and have a
back-up plan. One way to avoid problems with various government
entities is to make sure Fedex communicates with and between the
central, regional, and local government agencies, which often do not
speak to each other.


8. (SBU) Fedex works closely with government agencies to make its
work smoother. Nonetheless, it still faces problems with how
Chinese Customs manages its score system for problem shipments.
Fedex currently handles 10,000 shipments each day in South China and
Customs counts each package as a separate shipment. In 2006,
Customs found eight problem packages in Fedex and counted each as a
violation in its scoring system. Trucking firms, on the other hand,
have their shipments counted per truck load, regardless of the
number of individual packages being shipped. Fedex is working with
Customs to help draft a Customs clearance handbook. The first draft
will be out in two months and will be field tested by Customs at
Fedex's Hangzhou hub. Fedex also finds working with the State
Administration of Industry and Commerce (SAIC) a challenge at times,
given the view by bureaucrats there that it is their interpretation
of policy that counts, not necessarily the intent of the policy
itself. As the agency which issues many licenses, Fedex runs into
conflicts between national policy and local interpretation, making
the process of getting a license time consuming and difficult.


9. (SBU) Fedex faces a number of other problems, several of which
are contained within the transportation regulations and postal laws
which prohibit them from sending express mail deliveries into the
city. Postal laws favor the State-owned competitor and are being
written behind closed doors. Under the transportation regulations,
cargo vans cannot enter the city while passenger vans can enter but
cannot carry cargo. Yim noted that Hong Kong has similar rules but
allows more flexibility and controls business traffic at different
times of the day. China is strict on this issue. This rule only
applies to express delivery services, but not normal cargo firms,
and appears to be designed to protect China Post's Express Mail
Service (EMS). In this case the regulator is the competitor.
Despite agreeing not to deliver letters or packages less than 150
grams, the Postal Service still sends inspectors to check Fedex's
sorting facilities, which stops operations until the inspectors are
finished, slowing deliveries.


10. (SBU) Buying out its joint venture partner DTW, to be announced
and finalized on 1 March, should solve some problems as Fedex will
also acquire Da Tian W. Group's (DTW) Class One transportation
license to operate its own ground fleet and do domestic deliveries
but it will not fix the underlying legal issues and favoritism shown
to China Post's EMS. Fedex will need to register all of DTW's
former branches and will convert DTW's vehicle delivery fleet to the
Fedex logo. It will increase the number of employees to 6,300 and
improve service to China's secondary and tertiary cities. Chu said
that this deal was delayed by a MOFCOM review as well as varying
local practices in each locale, particularly for license
applications, opening company bank accounts in each city, vehicle
registration fees, and even advertising fees for the Fedex logo on
each delivery vehicle. Land use issues remain a concern. Fedex has
been trying to open a station in Dongguan for four years but has not
been able to obtain a land use certificate. The local government, a
district in Dongguan, told Fedex there would not be a problem but
without a legal use certificate, that verbal permission entails
legal risk. Another potential issue is how China Southern Airlines,
China's largest airline, will react to the new Fedex hub in its
backyard and the possible impact on China Southern's cargo business,

GUANGZHOU 00000206 003 OF 003


though Yim said that over the years China Southern has become "more"
reasonable. One problem Fedex cannot solve is the shortage of air
traffic controllers. Yim said that China produces only 120
controllers each year when it needs at least 400.

Hub Facts in Guangzhou: Transportation Links are Key
-------------- --------------


11. (SBU) To support the expected growth of the logistics market
and increased air traffic, Guangzhou will in turn accelerate the
construction of its third runway. The airport wanted Fedex to pay
for the runway but Fedex is happier sharing it with other airlines.
Baiyun Airport will have a total of five runways once its Phase II
construction is completed by 2010. In keeping with its business
model, Fedex aircraft will fly only at night, a factor which will
also keep conflicts with passenger aircraft to a minimum.


12. (SBU) Fedex currently has plans for a 24,000 square meter
sorting facility, expandable to 48,000 sq. mtr. The facility will
have 24 gates capable of handling wide-body aircraft and four feeder
aircraft gates and can expand up to 37 gates. Located 2.5 miles
away from the main passenger terminal, Fedex also achieved another
first, obtaining approval to operate its own ramp control with its
own ramp control tower. Yim said it is unusual for a private
company to get such approval - restricted only to the ramp - but it
will help Fedex manage its flights efficiently before handing them
off to the main control tower. Still to be worked out is how the
hand off to the ramp tower will take place.


13. (SBU) In China, trucking will play a big role in package
delivery. Connecting the airport hub to the Zhuhai-Beijing highway,
trucks will roll down "Fedex Road" if the package is to be delivered
within 350 km. Between 350-500 km, packages will go by feeder
aircraft, and over 500 km, packages will go by wide-body freighters.
Fedex currently lacks the ability to facilitate intra-China
transfers. As a result it has helped OKAY Airlines, a low cost
carrier, finance the acquisition and conversion of two Boeing 737
aircraft. OKAY will operate out of the Hangzhou hub.


14. (SBU) Fedex is exploring rail options in discussions with the
Kowloon-Canton Railway (KCR),which is planning to extend a rail
line beyond Guangzhou to the airport in the next several years. A
subway line will also be built to the airport in 2009. Guangzhou is
building a new rail center in Panyu and a high-speed rail line
connecting Hong Kong to Panyu. Fedex officials noted that Hong Kong
is studying rail and cross-border trucking and Customs clearance
procedures in order to promote Hong Kong as a freight destination,
however the Hong Kong government is not interested in cooperating
with Fedex at this time, fearing job losses in Hong Kong.

Go West?
--------------


15. (SBU) Fedex started its China operations in 1984 and entered
into a joint venture with DTW in November 1999 with 300 employees.
Fedex China now has 3,200 employees. In addition to its Beijing
office, Fedex has 26 branches and three gateways. East and South
China represent over 80% of Fedex's volume in China. Fedex
currently serves 200 cities through its JV partner. For the moment,
Fedex is content to develop its two hubs but is planning its
expansion into western China once the business is there to support
it. Once it raises its shipping volumes and is operating the hubs
smoothly, it plans to develop a series of 22 airport spokes in China
to be served by the hubs. These would include major cities across
China, including Urumuqi, Chengdu, and Xian. Yim is confident that
Fedex will improve the efficiency of China's logistics industry,
helping the Develop the West Program with the efficient movement of
parts and products in and out of western China.

GOLDBERG