Covid-19 lockdowns contributed to higher e-commerce volumes globally, and this played out on a grand scale in China. The country’s leading delivery firm, ZTO Express, saw shipments surge 40 per cent last year, similar to growth seen in markets like the UK and the US. Yet the volumes were astonishing: ZTO delivered around 47 million parcels a day - more than volumes of FedEx, DHL and UPS combined.

Manufacturing and moving all those boxes, envelopes and packages adds up to a staggering amount of fuel emissions, and paper and plastic consumption, an obvious area of concern to investors focused on sustainability. But the sector is also grappling with a price war driven by fierce competition, which has been pressuring many Chinese delivery companies to cut corners.

Against this backdrop, Fidelity’s investment team has been engaging in a running dialogue with ZTO’s management over the past two years that has contributed to the company’s embrace of more comprehensive standards of disclosure around the environmental, social and governance (ESG) impact of its rapidly expanding operations. One direct result of this engagement is that the company has become China’s first express delivery firm to publish regular standalone sustainability reports, and to make the pioneering move of linking executive compensation to sustainable performance. Amplifying the impact, others in the industry have taken notice of ZTO’s sustainability push and are starting to follow suit. 

“When the market leaders set a precedence of using biodegradable boxes or fuel-efficient trucks, that will drive other players in a competitive industry,” said Fidelity International equity analyst Terence Tsai. “We feel we can engage the entire industry by getting a market leader to make the first move.”

Early-mover advantage

In early 2019, Tsai first reached out to ZTO executives to discuss an unfavorable ESG report written by a third-party rating agency. A lack of sustainability disclosures was partially to blame for the poor rating that ZTO had received. Going through the report line by line, Tsai explained global ESG standards to company officials while stressing the importance of regular and quality disclosures.

The company’s response surprised even Tsai, who said he had kept his expectations modest in early engagement efforts, given how competitive China’s express shipping sector had become. A worsening price war has threatened the financial health and even viability of some smaller competitors, although ZTO has managed to stay profitable. While the company widened its market share to about 20 per cent last year amid booming e-commerce volumes, gross margin slumped to 22.5 per cent from the 29.2 per cent reached in 2019.

“When you are fighting to survive in the industry, you would think ESG is probably put on the backburner versus priorities like market share and profitability,” Tsai said. “I was very surprised and encouraged to see the market leader taking a serious ESG approach.”

Founding chairman Lai Meisong, a carpenter-turned billionaire, later showed us over the course of many meetings that he has the long-term vision needed for pursuing high ESG standards, even in a challenging business environment.

Steady progress

In late 2019, ZTO published its first ESG report, setting a good example for the young industry. Competitors SF Holding and Best soon followed suit. Moreover, ZTO’s board passed a motion last year to integrate more sustainable practices into daily operations and to reflect them in senior management compensation, in line with our advice.

Environmentally, a key improvement made by ZTO in the last two years was the reduction of paper documentation. Fidelity advised the company on this, and the change was also driven by another ZTO investor Cainiao, the logistics arm of e-commerce giant Alibaba, sharing industry best practice. By introducing e-waybills and smaller sheets of paper for the printed documents, ZTO has reduced paper consumption per package by 70 per cent, saving some 50,000 tons of paper each year. That is equivalent to saving 850,000 trees or 500,000 tons of carbon emissions. In addition, it has started to recycle packaging materials and experiment with new-energy vehicles. A fleet of more than 7,000 high capacity trucks have replaced less efficient vehicles, each saving two litres of fuel per 100 km and reducing 15 tons of carbon emissions a year.

Profit sharing

When it comes to social and governance issues, ZTO also stands out from competitors for its well-aligned interest among stakeholders. Like most peers, including STO Express, YTO Express and Yunda Holding, the company relies on franchisees to keep up with the fast pace of China’s e-commerce growth, though SF Holding has been an exception with a direct-control model. Franchisees often handle the pickup and last-mile delivery, while companies like ZTO operate a network of sorting hubs which are more scalable. What sets ZTO apart from competitors is that it has turned many of its franchisees into shareholders and thereby minimised disputes over profit sharing. Having shareholder franchisees allows the company greater control over the well-being of drivers and riders. This model is likely to have helped the company avoid labour disruptions last year when some rivals suffered strikes over wage arrears at the franchisee level.

The industry in general is prone to work accidents due to a strong emphasis on speed and a huge number of temporary workers, who are often hired to cope with seasonal spikes in orders around key retail dates like November 11. On the world’s biggest retail ‘holiday’, known as double 11 or Singles Day in China, the country’s e-commerce giants tallied nearly one trillion renminbi ($152 billion) in combined sales last year. Nevertheless, ZTO took measures to minimise work hazards among both temporary and long-term staff, including thousands of hours of training, in line with Fidelity’s advice.

Home of delivery giants

Chairman Lai founded the company in early 2000s in the eastern China county of Tonglu, the home of no fewer than four modern express shipping giants that together control more than half of the market today. Contrary to some presumptions about family operations being focused only on the near term, Lai says he is building a business empire beyond his own generation, aspiring for not only market dominance within China, but also global leadership, emulating firms like FedEx and UPS. 

To be sure, the progress we have seen in ZTO’s sustainable push represents only a small step forward for the industry. For most Chinese delivery firms, the top line and the bottom line remain prime focuses as they face tough competition and low awareness of sustainability in the general public. They have a lot of catching up to do compared with global industry leaders like FedEx, which has set a 2040 target of carbon neutrality, and DHL, which is working towards zero emissions by 2050.

With 83 billion express parcels swirling around China last year, the country’s delivery market has become a key battleground for achieving global carbon neutrality in the next few decades. Bringing sustainability here will mean broader benefits for society that extend beyond just the financial rewards, and ZTO looks to have helped set off a positive chain reaction towards that goal.