An analysis of Temu’s cross border supply chain & logistics (2/2)

This article was originally published in Chinese. The views expressed are those of the authors and not of Momentum Works.  This is the second part (Q&A transcript), read the first part (the summary) here.

You can also find out more about Temu’s strategy and operations in Momentum Works’s “Who is Temu” report. 

Q&A:

Q: What are the characteristics of Temu’s cross-border e-commerce logistics?

A: The products sold on Temu’s official website have three main characteristics: First, they are low-priced; second, they have smaller average volume and weight compared to similar domestic platforms, and the products sold are mostly lightweight items like jewellery and accessories; finally, the promised delivery time is relatively relaxed, usually providing a range of delivery dates rather than a specific day.

Q: How does Temu manage its logistics costs?

A: Temu manages its logistics costs in two main ways: firstly, by prioritising the use of tail-end flights, i.e., selling the remaining transport space at a low price to Temu when the aeroplane has already reached break-even; secondly, by combining heavy goods (like electronics with batteries or CPUs) with lightweight goods (throwaway goods) for transportation, fully utilising the plane’s total volume and load capacity, thus achieving freight cost savings. Choosing air transport as the main mode of transport and adjusting transportation strategies for tail-end flights is one of the keys to reducing logistics costs for Temu.

Q: How does Temu build its supply chain network?

A: Based on the above methods, Temu needs to build its own supply chain network and choose locations with dense flight schedules that can provide enough heavy goods to match, as its main receiving warehouses. Currently, Temu has chosen the Pearl River Delta, including Hong Kong, Guangzhou, Shenzhen, etc., because these areas have strong transport capacity, with abundant tail-end and heavy goods resources. Additionally, since Temu does not have its own heavy goods resources, it cooperates with freight forwarding companies with such resources, bundling calculations to save on freight costs.

Q: How is Temu’s logistics distribution conducted in the United States?

A: Due to US legal restrictions, Temu cannot build overseas warehouses in the US for local distribution. According to US laws revised in 2015, individual consumers can import goods tax-free up to $800 per day, but if Temu’s US subsidiary imports and then redistributes, tariffs would be required. Therefore, Temu sends goods directly from the source to US consumers’ homes. Inland distribution within the US is coordinated through freight forwarding companies with local service providers like USPS or UPS. Through this method, Temu achieves another layer of cost savings. The entire supply chain structure is actually divided into three stages: domestic warehousing and initial transport, domestic to US mainline transport, and local delivery within the US. Each stage seeks cost-effectiveness maximisation through partner selection and operations.

Q: If Temu’s sales this year are $14 billion and reach $30 billion next year, what scale of air freight volume will the demand side bring? Can this be estimated?

A: For Temu, considering its best-selling products average $3 to $4, and the average package price per item is about $15, a sales volume of $30 billion means approximately 2 billion kilograms (or 2 million tons) of freight volume. Considering that each Boeing 747 can carry 100 tons of cargo, this is equivalent to about 20,000 747s in volume. It requires about 40 to 55 747 flights per day, meaning that next year, about 40 Boeing 747 or fewer medium-sized aircraft like Boeing 767s may be needed daily.

Q: What is the impact of Temu on warehouse and freight forwarding demand? What is the proportion of Chinese airlines in the overall capacity?

A: The air freight demand brought by Temu is mainly controlled by China, which may need to allocate some quotas to the US. From a capacity perspective, it’s divided between domestic Chinese airlines and foreign airlines providing transit services, for example, from Hong Kong via Tokyo to the US, where goods don’t need to change planes at transit points. Chinese airlines roughly account for 1/3 of the overall capacity, and if charter flights are considered, the proportion is roughly equivalent. In general, Chinese airlines need to operate about 15 full cargo planes daily, like the 747, to maintain the corresponding market size.

Q: What is the proportion of cross-border e-commerce goods in the air freight market and their impact? Can air capacity meet Temu’s future needs?

A: Although cross-border e-commerce accounts for 50% of the air freight portion, the actual weight does not account for 50%, as charges are usually based on volumetric weight. If further capacity increases are needed, there are two main approaches: optimising packaging to improve the conversion rate or global airlines adjusting existing routes to accommodate demand. Currently, high growth in cross-border e-commerce is certain. In the future, more cargo planes are expected to be allocated to China to meet export demands.

Q: What is the situation with air freight rates? Why did rates peak in 2021 and then decline, and what are the reasons for the rebound in the fourth quarter after bottoming out in the third quarter, and its sustainability?

A: The reason for the high air freight rates in 2021 includes the impact of worker strikes on sea freight and the special demand for air freight during the pandemic. The decline in 2022 was mainly due to US interest rate hikes and the recovery of global aviation supply. By the fourth quarter of 2023, as capacity returned to normal levels combined with issues in the supply of pilots and other related personnel, rates began to rise. Considering the time needed to recruit and train new pilots, as well as the shortage of aircraft maintenance engineers and cargo handlers, future growth in planes and capacity faces challenges. Therefore, it seems that rate increases may be somewhat sustained.

Q: What types of products are Temu’s main competitors?

A: Temu’s main competitors are unbranded or so-called white-label products, such as Dollar General, Sunlight, Wal-Mart’s Great Value, and Amazon’s AmazonBasics, etc.

Q: What are the driving factors behind Temu’s sales growth?

A: There are two main drivers of growth. First, the third quarter is the back-to-school season, with a clear seasonal demand increase. Additionally, due to the fourth quarter including Thanksgiving and Christmas, these holidays lead consumers to prefer buying cost-effective white-label products. Economic factors also play a role; if the economic situation leads to a “lipstick effect” in the US, consumers may choose brands like Temu due to budget constraints for high-value products.

Q: What are Temu’s advantages in cross-border logistics?

A: Temu’s biggest advantage in cross-border logistics is its ability to leverage US laws exempting imported goods under $800 from taxes, giving it a significant competitive advantage. It’s unlikely that US tax policies will change because requiring all goods to be taxed would create a huge US customs declaration backlog, undoubtedly affecting tax collection efficiency. As such, Temu’s competitive advantage in this area is likely to continue.

Q: Does Temu have plans to build warehouses in Mexico? What impact would this have on its performance?

A: Temu plans to establish warehouses in Mexico, allowing direct shipping to the US rather than exporting from China. This change will help Temu reduce costs, and if the macroeconomic environment remains stable, the company can look forward to optimising its supply chain and improving its performance through this move. In the competitive landscape of the future, Temu’s performance fundamentals are unlikely to change next year if they remain the same.

Q: What are the expected supply and demand dynamics in the air cargo market next year? How will rates change?

A: Although there’s an approximate 10% increase in national air cargo deployment, the growth rate of supporting personnel, especially airport staff, may not keep up, so the actual increase in total supply may be lower than 10%. On the other hand, there may be a significant increase in the number of domestic flights next year, driving total demand to increase by more than 10%. Therefore, under the overall supply and demand pressure, rates may be stronger than expected. When comparing peak seasonal rates, such as Black Friday, next year’s rates compared to the same period last year should be able to increase.

Q: What is the current situation of Temu’s cross-border logistics supply chain costs?

A: Based on our calculations, Temu’s cross-border small parcel logistics costs are very low, for example, from Guangzhou to the US, each small parcel’s freight cost can be as low as a few tens of cents, usually around 60 to 70 cents. This low cost is based on the bulk aggregation of goods for unified packaging. If considering consignment as a mode of transport, the cost of consignment is calculated separately per item, as there are minimum price standards.

Q: What measures does Temu take to optimise its logistics costs?

A: First, Temu has established warehouses in Mexico, where goods are shipped from China before entering the US market. This approach has cost advantages as shipping from Mexico to the US is more economical than purely domestic US distribution. Second, Temu optimises costs through direct delivery services, for instance, by transporting goods directly from the airport to USPS sorting centres, which offers certain price benefits. Additionally, Temu is negotiating with USPS to seek more favourable terms. For consigned parts, Temu is negotiating with courier companies like USPS and UPS to obtain competitive prices.

Q: What specific tax advantages does Temu’s warehouse in Mexico have?

A: According to US law, if Temu established warehouses within the US, it would become an official importer and would need to pay tariffs. However, by establishing a transshipment warehouse in Mexico, Temu can take advantage of US regulations to exempt small-value goods under $800 from tariffs. Additionally, shipping goods from Mexico to the US incurs no tariffs, and the Mexican government might even provide subsidies, making the conditions significantly favourable.

Q: What is the current situation of the air freight market and the trend of long-term contract prices?

A: At the end of last year, due to the restoration of goods reserves leading to an oversupply, airlines had weaker bargaining power in negotiations for long-term transport agreements (long-term prices). However, the situation has changed this year. As the airlines’ capacity is already saturated, and the addition of new capacity to routes is limited, airlines have a stronger negotiating position in this year’s long-term transport agreement negotiations. Now, airlines typically demand either higher prices or advance booking. As a result, this year’s air freight price landscape has reversed, and the dynamics of negotiations have changed, with airlines under capacity pressure likely demanding higher prices.

Q: Can you explain the current situation of the airline market, especially the role of small airlines and supplementary warehousing, and their impact on freight rates?

A: Major airlines show strong confidence in their capacity in the Chinese market, even displaying a relaxed trend, while some small airlines are entering the market to take a share, signifying that freight rates have already started to rise. One characteristic of supplementary warehousing is that the destination is not fixed, leading to small-scale replenishment each time, hence not economical. 

In fact, since few goods are replenished, consignment increases costs. Although everyone flies the same distance, the real challenge lies in the human cost of consignment. Even if the US-China routes are restored next year, whether the newly added capacity can meet e-commerce demands remains a question. Theoretical supplementary warehousing capacity is not equivalent to the actual capacity sold in the market, as it depends on the total volume of passenger checked luggage and other factors, such as refuelling amounts. Therefore, the actual saleable supplementary warehousing capacity is always limited.

Q: Is Temu attempting to establish a fast shipping service, and what impact would transport from China to the US have on its inventory and supply chain model?

A: Temu’s core strategy is to ship goods directly from outside the US to the US By transporting large quantities of goods to Mexico’s bonded warehouses before shipping, they can save costs. The purpose of fast shipping is to improve transport efficiency, as a container can hold much more cargo than an air cargo container. Fast shipping may initially start as a pilot, focusing on best-selling and stockable goods. This pickup model is new for Temu, and the scale won’t be large initially. They also need to first establish a distribution network from Mexico to the US before expanding the scale of Mexico’s bonded warehouses. This means that even with fast shipping, it takes 12 days, so apart from bulk goods, most long-tail goods will still rely on air transport. Shipping and Mexican bonded warehouses are measures for Temu to reduce logistics costs, but this is a gradual process and cannot be achieved overnight. It is expected that next year, goods transported in this way could account for 10% of the total volume, which would already be quite good.

Q: Who are the main service providers in Temu’s supply chain? What role does the warehouse built in the US play if it cannot build and distribute from overseas?

A: Temu’s criteria for choosing suppliers are based on two main factors: who has the necessary tail goods (excess inventory), and who can offer the lowest price. Since Temu’s business model mainly focuses on tail goods and distribution, its suppliers are usually not fixed but are determined based on inventory and price. Therefore, Temu is unlikely to have a large single supplier, but rather a variety of small suppliers and so-called middlemen to provide services. 

Although the final transport may be undertaken by major airlines like Eastern Airlines, Southern Airlines, and Cathay Pacific, the goods may have already been through multiple rounds of handling. The warehouse established in the US primarily deals with returns. Considering the high return rate under the culture of unconditional returns, establishing a local warehouse in the US helps complete local secondary sales, avoiding the need to ship returned goods back to China. The warehouse, serving as a site for secondary clearance, can repackage and resell goods, thus handling returned items and re-entering the market.

Q: Does Temu have its own freight forwarding service provider, and if so, how is the cooperation?

A: Temu explicitly states it does not intend to become a freight forwarding service provider (general sales agent – GSA). This is because if Temu starts providing freight forwarding services (general freight carrier – GFC), it will directly compete with the entire freight forwarding industry. Temu’s business success relies on a reasonable mix of light and heavy goods. Without heavy goods, becoming a logistics provider could lead to increased logistics costs. Airlines usually charge higher freight for e-commerce goods without a mix of heavy goods. Currently, Temu may entrust several service providers to cooperate, adopting an open, wide-net strategy rather than building its own service network.

Q: By adopting shipping, how much can Temu reduce per-order fulfilment costs? How many goods are suitable for sea freight stocking?

A: Since Temu’s core business is tail-end air freight, it is difficult to directly compare the costs of air and sea freight. The cost savings from sea freight may be up to about 20% for the mainline part to Mexico. Temu chooses fast ship partners, like Maersk, to reduce delivery time and prepare for stocking. 

However, the goods suitable for stocking are mostly top-selling items, and it is questionable whether these can reach 20% of Temu’s total volume. For stocking, at most only 10% to 20% of best-selling goods account for about 30% to 40% of the total shipment volume. Even these stocked goods might partially arrive in Mexico by air, as the price of air freight tail goods is sometimes very cheap, even lower than sea freight. 

On the other hand, due to the demand for “heavy goods balance,” freight forwarders might offer Temu more advantageous air freight rates to ensure smooth shipment of heavy goods. Therefore, although a certain proportion of goods will start stocking mode, the rest may still be transported by air, depending on the specific agreement signed with the fast ship company.

Q: How much has Temu’s warehouse cost in Mexico increased?

A: Regarding the increased warehouse costs, I cannot provide the exact amount on the spot, as it involves specific investment decisions. However, I can offer some reference data. Taking Monterrey as an example, the warehouse rent is about 40 RMB per square metre per month, which is about 6.47 USD. If we consider that the warehouse can be stacked up to 6 layers, then the cost per square metre of shelf space is about 50 cents RMB per month. Combining the inventory period of goods, the daily cost is about 5 to 10 cents. 

Therefore, the daily cost per item, including labour, is about 55 cents. This also explains why goods don’t stay in the warehouse for too long, as costs accumulate daily. In fact, these warehouses are more like distribution centres, used to quickly transport goods into the US market.