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M A N U FA C T U R I N G &
By Beth Mattson-Teig







China is in the throes of transformative change as its industrial and manufacturing markets continue
to mature. Those changes are having a sweeping effect on corporate location decisions, supply chain
management and business strategy.
In recent years, China has been working harder to distance itself
from its early role as a low cost producer of goods and position itself
as an advanced manufacturer and hub for innovation, R&D and higher
technology. China is moving up the value chain, and the investment
into the industrial sector has to recognize that and to look at where the
demand is going in terms of what products are being produced, says
Stuart Ross, head of industrial, China at JLL in Shanghai.

To get a clear picture of Chinas industrial and manufacturing

marketwhere it is at and where it is headedit is important
to first take a closer look at the countrys economy. China has
changed over the past decade from a lower world power to one
of the largest economies in the world. In fact, the International
Monetary Fund recently elevated Chinas rank from the second
to now the largest economy in the world valued at $17.6 trillion,



edging out the $17.4 trillion U.S. economy. Given that formidable
size, it is no wonder that signs of weaker economic growth have
sparked concerns about the potential impact of the slowdown.
As reported by the National Bureau of Statistics of China, the
annual growth rate in Chinas GDP averaged 9.08 percent from
1989 until 2014, reaching an all-time high of 14.20 percent in
the fourth quarter of 1992 and a record low of 3.80 percent in
the fourth quarter of 1990. However, Chinas growth has been
slowing since 2012. GDP expanded 7.30 percent in the fourth
quarter of 2014 over the same quarter of the previous year.
I think some of the concerns related to the slowdown in
economic activity and falling growth in GDP rate are perhaps
misinterpreted by the public outside of China, says Ross. If Chinas
GDP falls to a rate below 7 percent, then the perception outside
of China is that the country is falling into recession. However, you
cannot grow the China economy, which is as large as it is today, by
double digit GDP growth, notes Ross. In fact, JLL expects that GDP
growth will likely fall further in the coming years. Our internal
economists and research team believe that 5 percent by 2020 is
probably going to be a reasonable growth rate given the size of the
economy by that time, he says.

Chinas economic growth momentum has slowed down, but in

recent months there has been a bit of an uptick, adds Frank Chen,
executive director, head of research in China for CBRE. I think the key
reason is because the central government has witnessed a slowdown
in economic growth since the beginning of 2014, and they are
trying to rejuvenate the economic growth by what they call targeted
stimulating measures, he says. They do not introduce massive or
overall stimulating measures like what happened after the financial
crisis in 2009, rather they are just trying to provide more targeted
stimulating measures for stimulating industries.
Certainly, corporations are keeping a close eye on the potential
impact from slower economic growth. At the same time, the
industrial sector is evolving and companies have to adjust their
business in a changing market. In some cases, the numbers that
are produced, such as the slowdown in PMI or other manufacturing
indexes, reflect the slowdown of legacy businesses polluting
industries or industries that relied on generating power from coal.
Now there is greater re-direction of capital to cleaner industries
and value-added industries, notes Ross.

1 China GDP Annual Growth Rate. National Bureau of Statistics of China and Trading



Two key industries driving growth in Chinas industrial real estate market are manufacturing and logistics.
Both sectors are experiencing dynamic change. Rising labor and land costs are two of the key factors
shifting the manufacturing landscape.
Much of the manufacturing base is moving inland because of higher
labor costs and higher land prices along the coastal areas, says Chen.
There also has been a shortage of labor supply in recent years in areas
such as the Pearl River Delta and the Yangtze River Delta. As a result, some
manufacturers are shifting their operation base inland, to West China or
to other developing countries such as Cambodia, Thailand or Bangladesh.
Chinas trend of urban regeneration also is fueling a manufacturing
shift from first tier to second tier cities, says James Shepherd, MRICS,
executive director, head of research, Greater China for Cushman &
Wakefield in Shanghai. Even among second tier cities, a similar shift is
underway as undesirable industry or very low end manufacturing that
relies on unskilled labor at minimal costs moves further out to third and
fourth tier cities, he adds. As first tier cities continue to evolve we are
seeing migration of low tech industry to surrounding cities and provinces,
says Shepherd. The government is supporting this evolution as it raises
the game of the first tier cities as they position more towards tertiary
industry and meanwhile supports those less well developed cites with
secondary investment, bringing valued employment and tax revenues
whilst supporting the development of local business hubs and clusters.
There is still a massive stock of low end manufacturing space in second
tier cities, much of which is owned by local businesses that are becoming
increasingly sophisticated in their production needs, says Shepherd.
These old facilities are outdated and becoming inefficient to operate. In
highly evolved first and second tier Chinese cities local governments and
customers are increasingly challenging such factory owners on subjects
such as safety for workers, whether or not building code is being met
and pollution, he says. Meanwhile, staff turnover is a continual problem
and staff costs in well developed areas are growing quickly. For many
such business owners a relocation therefore makes a huge amount of
sense and creates an abundance of new real estate opportunities and
cost savings, he adds.

Another notable trend in the manufacturing sector is the emergence

of industry clusters. There is a lot of clustering going on in China,
and companies are more comfortable relocating to an area where
like firms are already located, because they know they are going to
have, perhaps the utilities support for their particular industry, or the
government support or the suppliers or sales market that is accessible
to that location, says Ross.
Auto manufacturing, for example, is developing huge hubs in
all parts of China. Volkswagen and Toyota are among those auto
manufacturers that have set up manufacturing bases in Chengdu.
Wuhan is another strong auto center with the likes of Nissan and
Peugeot. Hyundai Motor Co., for example, is expanding its operations
in China with two new production facilities. The company currently
operates three manufacturing facilities near Beijing and is building
two additional factories to boost its production. The new Hyundai plant
in the Hebei province is expected to start production in 2016, while
a second plant in Chongqing will be completed in 2017. In addition,
General Motors Co. reportedly plans to invest $12 billion to build more
plants in China by 2017, and Volkswagen AG plans to invest $22.1
billion in China by 2018.
Industry clusters is a concept that has been adopted by many
local governments, says Chen. For example, a number of Tier II
cities, such as Chengdu and Wuhan, have adopted new high-tech
economic development zones. Chengdu also has invested heavily
to attract high tech manufacturers such as Intel and Foxconn. In
addition, technology clusters have developed within some business
parks. It is the idea that is adopted by a lot of local governments, but
whether they can be as successful as Californias Silicon Valley is a
question that has yet to be answered, he adds.

2 Hyundai Expands Plans for Additional Chinese Production. In-Soo Nam. The Wall Street
Journal. Dec. 30, 2014.



The logistics industry is a vital part of Chinas broader industrial market, and it too is undergoing significant
sea change. According to JLLs China50 report, the logistics network is the backbone of economic growth
and continued modernization in China.
As low-cost manufacturing moves outside of China to other
low-cost countries, logistics is increasingly being steered by
the supply chains of value-add and advanced manufacturing
industries, such as auto manufacturing and technology.
In addition, the logistics market is feeling more and more pressure
to supply Chinas surge of middle income consumers. Double digit
sales growth in both traditional retail stores and online e-commerce
is fueling more demand for growth in the logistics sector. At the
same time, the logistics market continues to battle challenges that
include a high cost of transporting goods and limited supply of
quality warehouse and distribution facilities.
China has made significant investment in improving its transportation
infrastructure, most notably roads, rail and airports. However, one of the
stumbling blocks in the logistics sector is that the market is still heavily
undersupplied in terms of high quality, efficient facilities, notes Ross.
The undersupply is an important topic for both occupiers of space and

investors and developers. The U.S., for example, is home to a population

of about 320 million. In comparison, Chinas rapidly growing middle
class has already exceeded that and is projected to reach 630 million
by 2022, according to a report by McKinsey & Company.
Now compare the supply of warehouse space in the two
countries. In the U.S. there might be 160 to 170 million square
meters of high quality space in modern logistic facilities. In
China, there is less than 50 million square meters in that sector,
says Ross. So China has a significantly larger market, yet it
has only about one-quarter or one-third of the warehouse and
distribution stock. In addition, the cost of transporting goods and
the cost of the overall supply chain is much higher in China than
compared to the U.S. or other mature markets. So there has got
to be ongoing rationalization of the supply chain, otherwise it will
be difficult for companies to move from older facilities to newer
facilities with higher rents, he adds.

3 China50, Fifty Real Estate Markets that Matter. JLL. 2012.

4 Preparing for Chinas Middle Class Challenge (Part 1). Gordon Orr. McKinsey & Company.
March 31, 2014.



Another key macro trend in China that is impacting both the manufacturing and logistics sectors is explosive
growth in its consumer market. Despite the slowing economy, there is still very good double digit retail
sales growth in China.
Year over year retail sales growth in China averaged 14.56 percent
from 2010 until 2014. That growth has slowed in recent months with
November data showing year-over-year sales growth of 11.7 percent,
according to data from the National Bureau of Statistics of China.
Much of the logistics growth has been concentrated around the
Tier I cities to support the large populations that exist in major
cities such as Shanghai, Beijing and Nanjing. Companies tend to
locate regional distribution centers closer to those Tier I cities and
are increasingly consolidating several smaller facilities into one or
two major regional distribution centers that offer some efficiencies
and economies of scale. Companies are not just moving from one
facility to a better quality facility, but consolidating a number of
facilities into one larger regional distribution facility, says Ross.
However, that middle class is expanding into smaller cities and
provinces more in central and western China, as well as to the north and
south. Therefore, the distribution and logistics facilities are also growing
in those regions. Yet there is not a great supply of available modern
logistics facilities available in these areas. We are undersupplied in
most of these provincial capitals, as well as the Tier II, Tier III and even
the Tier IV cities that have a growing middle class, says Ross.
Chinas booming e-commerce market also is having a powerful
impact on the logistics sector. China is reportedly home to the worlds
biggest online population and online shopping has skyrocketed in
recent years. Chinas online retail sales, including both consumer
shopping and business-to-business sales rose nearly 50 percent in
2014 to reach $2.09 trillion, according to Chinas National Bureau of
Statistics. For example, during its annual 24-hour Singles Day online
shopping promotion on Nov. 11, 2014, Alibaba said that consumers
spent a record $9.3 billion, which was a 60 percent increase over 2013.
Logistics activity has traditionally been concentrated around the Tier
I markets and the satellite cities surrounding those Tier I markets for

several reasons. However, the land costs can be significantly lower

outside of Tier I markets. That really makes a huge argument when
transport companies and the retailers and occupiers themselves are
trying to maintain efficiency and cant afford the rents in Tier I cities,
says Ross. Over the last five years we have seen very high growth in
satellite locations outside of the key centers, he says. For example,
warehousing is virtually non-existent in Beijing. So companies have had
to move to other satellite cities such as Langfang, which is centrally
located between Beijing and Tianjin. Kunshan also is developing as a
major logistics hub between Shanghai and Suzhou, according to JLL.
Over the next decade, JLL expects the balance of logistics activity
to shift to central and western China. Chengdu is positioned as the
largest inland logistics hub and is experiencing strong development
activity. Based on an analysis of infrastructure development, business
openness, economic size, GDP growth and retailer activity, the cities
with strongest growth potential are likely to be:
Emerging Primary Hubs Chengdu,
Chongqing, Wuhan and Shenyang
Emerging Secondary Hubs Changsha,
Zhengzhou, Hefei and Xian

5 China Retail Sales YoY. National Bureau of Statistics of China and Trading Economics.

6 Chinas e-commerce transactions hit $2 trillion in 2014. The Economic Times.

Jan. 21, 2015.
7 China50, Fifty Real Estate Markets that Matter. JLL. 2012.



The evolution of the economy and growing middle class are influencing manufacturing and logistics location
decisions in China. Other important considerations include labor availability, supply chain risks, operating
costs and government policies.
Certainly, the government still carries powerful influence on location
decisions in a variety of ways, such as its urban regeneration efforts,
improved infrastructure, development of quality commercial properties
and logistics facilities, business support, tax incentives, improved
education, land swaps, environmental policy and land use policy amongst
many others, says Shepherd. Companies also need to maneuver a number
of challenges and obstacles such as staffing, interrupted or insufficient
power supply, security of the working environment, goods or intellectual
property, as well as the risk of agreed upon special tax treatment not
being forthcoming in poorer areas, adds Shepherd. Specific to real estate,
some of the added risks could include contaminated sites or fly tipping of
contaminated material on site, site clearance, soil compaction, inadequate
site infrastructure, land title issues, stratification or unclear ownership
structures and poor construction quality.
In the past, there was more emphasis on having the infrastructure
support for business operations. However, infrastructure development

has been huge in recent years with improved access to power and
water. Environmental issues now are becoming a very important issue
to local governments. So, companies that have any level of potential
environmentally polluting output are finding that they are being forced out
of Tier I and Tier II cities and into new locations, notes Ross.
One of the challenges that companies face in China when locating
new facilities or expanding existing operations is choosing locations
that will still be relevant and viable in five, 10 or even 15 years as the
economy, its manufacturing and industrial industry and its consumer
markets continues to evolve. China now has more than 160 cities
that are home to more than 1 million people. So, from an investors
perspective, you can pick any 10 cities and do quite well, but it is a
very competitive environment and it is hard to look at China and say
here are the hot spots you really have to drill down and compare cities
within provincial locations to each other to determine what is going to
be competitive and a good investment opportunity, says Ross.

Special thanks to the following companies for their research assistance:



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