Much of the conventional wisdom about the reasons for India's relatively high logistics costs is simply wrong
Logistics—moving goods and connecting producers with consumers—is a critical part of the modern economy. In India, this sector comprises 14% of gross domestic product (GDP), much higher than in the US or Europe, where it is 8-9%, according to McKinsey research. That matters; High logistics costs hurt Indian competitiveness.
The government’s various initiatives, such as setting up a division in the Union ministry of commerce, introducing a national goods and services tax and giving infrastructure status to logistics, may help reduce inefficiencies. This new sense of urgency is welcome, but in order to find the right solutions, it’s important to establish what the real problems are. In a recent study, we found that much of the conventional wisdom on the subject is simply wrong. Here are four examples.
The first myth is that direct costs are the key reason for India’s high-priced logistics. The reality is that indirect costs are the real culprit.
Direct logistics costs are those incurred in the process of moving goods, such as transportation, warehousing, and value-added services. Indirect (or “hidden") costs include inventorycarrying costs, theft, damages and losses in transit; these account for 40% of India’s total logistics costs of $270-310 billion. Indirect costs are caused by inefficiencies in the supply chain; in developed countries, they are typically less than 10% of the total.
A comparative study under the Sagarmala programme shows that for exporting a container from Delhi, the total inland transit time till loading on to vessel can vary from 7-15 days, while the inland transit time for a similar route in China would be five-six days. While it does take more time in India, the larger problem is the high variability; this reduces reliability and increases inventory carrying cost. Based on our analysis, an efficient supply chain with low variability in lead times and high service levels can cut inventory costs by up to 50-70%.
The second myth is that increasing the use of rail can significantly reduce the cost of logistics in India. The reality is that given the prevalence of short-haul movement of goods in India, there is limited room for growth.
India’s railroads carry no more than a third of the country’s freight; almost all the rest goes by road. Many people believe that this mix contributes to India’s high costs. Look at the situation a little more closely, though, and this analysis weakens. The great majority of the country’s cargo routes (about 450 out of 500) are less than 800km long. The rule of thumb is that rail makes economic sense only on routes longer than that. On that basis, we estimate that rail’s optimal market share is no more than 38%.
An initiative that could help, however, is the government’s Rs8 trillion Sagarmala project, launched in 2015. This goes in an entirely different direction, by investing in ports and coastal areas, with the goal of increasing the use of domestic shipping in moving goods. If Sagarmala works as intended, we believe it could lower the cost of logistics noticeably.
The third myth is that to cut logistics costs, the focus should be on major commodities, such as coal and steel. The reality is that streamlining the agricultural value chain matters more.
McKinsey estimates that coal and steel account for about 12-16% of India’s total logistics costs; the figure for agriculture is about 25%. Moreover, inefficiencies in the agricultural supply chain, such as improper transportation and storage, are rife, leading to wasted food and quality control problems. There is a great deal of room for improvement in warehousing and storage. Refrigerated trucks, for example, aren’t all that useful if the warehouses at either end don’t have cold storage.
The fourth myth is that the major issue with road transport is the poor quality of roads and trucks. The reality is that the quality—and number—of Indian drivers is more important.
Roads carry more than 60% of India’s cargo and account for the majority of the total logistics costs; they therefore have the most potential to unlock savings. Many of India’s roads and trucks could be in better condition, of course, but benchmarking studies comparing India to other developing economies have found that the unit economics are not too bad. It is the scarcity of skilled drivers that is the bigger problem.
India’s ministry of road, transport and shipping estimates suggest a 22% shortage in the number of commercial drivers. Coupled with the low skill level of many commercial drivers, that means more delays and more damages—the root cause of the high indirect costs. Improving roads and truck quality without solving this issue will result in a very low return on investment.
Logistics firms are beginning to address this issue by opening driver training schools, boosting wages and benefits, investing in their drivers’ skills, using on-board sensors to monitor driving patterns, and then giving real-time feedback.
In some respects, India does well. The World Bank ranked it 35th (out of 160 countries) in its most recent Logistics Performance Index, which concentrates on trade-related factors, up from 54 in 2014. India was the top performer among lower middle-income countries. All too often, though, India falls short of excellence. Doing better requires looking at the logistics system from beginning to end, just as companies experience it, and then strengthening each link. For that to work, it’s best to clear away the myths first.
Neelesh Mundra, Abhinav Singh and Raghavendra Uthpala are, respectively, partner, engagement manager and associate at McKinsey & Co. in India.
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