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China's consumer market: What's next?

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Deloitte Research analysts foresee a consumer spending boom in China over the next several years and offer predictions about the evolution of the Chinese consumer market as well as likely strategic implications for global consumer oriented companies.

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Publié le 09 novembre 2011
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A Deloitte Research Study
Chinas consu What next?
mer market:
Table of contents
1 Introduction  2 Selling consumer products in China  4 Changing landscape for distribution  7 China’s retailing industry  9 The consumer economy in China  21 China and the internet  22 Short term economic outlook  23 Strategic requirements for success  24 Concluding thoughts
About Deloitte Research Deloitte Research, a part of Deloitte Services LP, identifies, analyzes, and explains the major issues driving today’s business dynamics and shaping tomorrow’s global marketplace. From provocative points of view about strategy and organizational change to straight talk about economics, regulation and technology, Deloitte Research delivers innovative, practical insights companies can use to improve their bottom-line performance. Operating through a network of dedicated research professionals, senior consulting practi-tioners of the various member firms of Deloitte Touche Tohmatsu, academics and technology specialists, Deloitte Research exhibits deep industry knowledge, functional understanding, and commitment to thought leadership. In boardrooms and business journals, Deloitte Research is known for bringing new perspective to real-world concerns. Disclaimer This publication contains general information only and Deloitte Services LP is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte Services LP, its affiliates and related entities shall not be responsible for any loss sustained by any person who relies on this publication.
Introduction
In the midst of a serious global economic crisis, in which China’s economy has markedly slowed, it may seem an odd time to offer an optimistic prediction. Yet all signs point to a consumer spending boom in China over the next several years. The global economy has reached an inflection point, in which the structure that existed over the past decade shifts dramatically. During the past decade, the engine of global economic growth was the US consumer. China grew largely by supplying exports to the US consumer market. Going forward, US consumer spending will grow more slowly as the vast imbalance in the US economy is corrected. Likewise, China’s export growth will lessen and the Chinese economy will experience growth based largely on domestic demand, especially the consumer. This will likely be brought about by a confluence of factors including a rising value of the Chinese currency. This very likely will reduce import prices and raise the purchasing power of Chinese consumers. In addition, China’s policymakers will probably stimulate consumer demand, discourage saving, and encourage industries that focus on the needs of Chinese consumers. For the world’s leading retailers and consumer product companies, most of which are based in North America or Western Europe, the rise of the Chinese consumer will have vast implications. The home markets of these companies are no longer sufficient to drive the growth shareholders seek. Not only are these markets saturated and increasingly fragmented, they are not likely to grow at sufficient speed in the years ahead. In the US, a decade of excessive consumer borrowing augurs a period of retrenchment and greater consumer frugality. In Europe slow population growth, combined with an aging popula-tion, imply stagnant growth and a shift in consumer spending away from goods and toward services. The same can be said for Japan as well. Instead, emerging markets are likely provide consumer oriented companies with an increasing share of sales and a disproportionate share of growth. The most notable such emerging market, of course, is China. With the world’s largest population, the fastest growing major economy during the past decade, the second largest economy in the world (when measured according to true purchasing power), and an increasingly sophisticated middle class, China will be indispensable. In this report, Deloitte Research considers the changing consumer business environment in China. The report offers predictions about the evolution of the Chinese consumer market as well as the likely strategic implications for global consumer oriented companies. The report is organized as follows: First, the requirements of selling consumer products in China are discussed. The changing distribution landscape and the evolution of the retail marketplace are also examined. Then, the report delves into the nature of the market, including living standards, spending behavior, consumer attitudes, consumer finance, demographics, and the increasing role of the internet. The report also looks at the current and near term economic environment facing consumers. The report concludes with a discussion of the strategic requirements for success in the Chinese consumer market.
Deloitte ResearchChina’s consumer market: What next?1
Selling consumer  products in China
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What does it take to succeed in the Chinese market for consumer products? Most of the factors for success are the same as they would be anywhere else, yet some are unique to China. Globally, consumer product companies face several challenges. These include an increasingly value-oriented consumer who is driven by price considerations. As such, they are attracted to private labels and discount retailers. In addition, the consumer market is increasingly fragmented, driven by an equally fragmented marketing experience. Also, power in the supply chain has shifted decidedly in favor of retailers as opposed to their suppliers. As such, consumer product companies are struggling to enhance their relationships with key retail accounts. In response to this business environment, success for consumer product companies will come from product innovation aimed at avoiding commoditization and retaining pricing power. In addition, these companies will shift incrementally away from mass marketing and toward networked interaction with consumers, the goal being to enhance brand equity and empower consumers in the process of product development. Finally, these companies will seek greener pastures in the form of emerging markets for future growth. That is where China comes in. In China, where most of the world’s leading consumer product companies already operate, success requires many of the same ingredients as in home markets. However, there are differences. First, as discussed later in this report, China lacks a national market — at least for now. Consumer product companies need to be organized around regions. They must develop distribution and focus their marketing messages according to the needs of local markets. These markets can vary considerably according to language/dialect, spending power, tastes, and consumer culture.
Second, although China is becoming more affluent, it remains a relatively poor country. Consumer products must be affordable. This requires a particular focus on cost of production, especially the cost of packaging. Most Chinese do not yet own automobiles and many travel to stores on foot or by bicycle. Thus, most transactions at hypermarkets and supermarkets are small not only in price, but in size. Thus, it makes sense to produce SKUs that are likewise small in size and price. Third, product innovation and enhancement must be geared toward the needs of local consumers. It would not be sufficient to simply replicate products that are sold in affluent markets. Appropriate product innovation naturally requires a strong understanding of consumer behavior. Traditional market research techniques are not sufficient in China as they tend not to render very useful insights. That is due to the tendency of Chinese consumers, when surveyed, to tell questioners what they want to hear. Instead, close observation is required. In addition, the Internet can be a useful tool for interacting with consumers and bringing them into the process of innovation. The great and growing enthusiasm on the part of young consumers for the Internet can be exploited to the benefit of consumer product companies.
Fourth, as millions of China’s consumers experience increased incomes, their incremental spending is not necessarily geared toward fast moving consumer goods. If a consumer becomes more affluent, they won’t neces-sarily purchase more paper towels, soaps, and detergents. Instead, they are likely to seek larger homes, electronic gadgets, and purchase services such as restaurant meals or holidays. Thus, the challenge for consumer product producers is to attract greater discretionary funds from such consumers. This can entail market segmentation in which consumers are encouraged to switch to a more premium brand. Such a sub-brand would have to possess features that appeal to a more affluent consumers and would have to be marketed as such. Finally, there is the issue of distribution. China’s retail market has become more sophisticated and consolidated than in the past. Yet it remains relatively fragmented compared to more affluent markets. There are countless small independent stores, street markets, and inefficient state-run retailers. Navigating this landscape can be costly. For global companies, focusing more resources on the modern retail sector is sensible in that it is more efficient, cost-effective, and will grow more rapidly in the future. In the near term future, global consumer products companies will continue to expand in the Chinese market. In some instances, this will be undertaken through acquisi-tion of local brands. The expectation will be that global companies can provide these brands with expertise in distribution, marketing, as well as deep pockets. The local companies will be expected to have a good understanding of local consumers as well as strength in low cost manu-facturing. The trick will be to combine the competencies of both organizations to make the whole greater than the sum of the parts.
There is a long history of surprises that Western companies have encountered when gaining control of Chinese companies, especially when the companies in question were state-owned. The challenge, however, will be to carefully perform due diligence when considering acquisitions. There is a long history of surprises that Western companies have encountered when gaining control of Chinese companies, especially when the companies in question were state-owned. Often the problem is that financial records are not sufficiently transparent. Another problem, mainly with state-owned enterprises, is that existing management is often chosen for and motivated by political considerations. Yet many acquisitions have involved obligations to retain management. Such arrangements can cause the benefits of an acquisition to unravel.
Deloitte ResearchChina’s consumer market: What next?3
Changing landscape for distribution 
When asked about their primary competitors, leaders of modern retailers in China are apt to list street markets and street vendors rather than other big box operators. They complain that street merchants pay no taxes and needn’t pay rent.
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The rise of modern retailing Modern big box retailers usually offer no price advantage over traditional wet markets and street vendors. Indeed the prices charged in the informal sector are often lower than those at modern retailers. Yet the moderns continue to gain market share — although that gain is mainly at the expense of state-owned department stores rather than the informal sector.
Why are consumers attracted to modern retailers? The answer is that modern retailers have several advantages. When it comes to food, they offer reliable hygiene, air-conditioning, and the convenience of one-stop shopping. In addition, modern stores stay open longer than tradi-tional markets and thus attract shoppers returning home from work late in the day. Also, consumers are generally confident that major fashion and home fashion brands sold at modern stores are not fakes, unlike those sold through informal channels.
Still, when asked about their primary competitors, leaders of modern retailers in China are apt to list street markets and street vendors rather than other big box operators. They complain that street merchants pay no taxes and needn’t pay rent. The result is low prices and a certain kind of convenience. The challenge for big box retailers is to retain the ambience of wet markets while offering the advantages of modern retailing. In the case of Walmart, managers at each store visit nearby wet markets and inde-pendent stores as often as three times each day. The goal is to see what items are selling well and at what prices. This enables Walmart to quickly respond to changing demand patterns.
Shopping centers Many large shopping malls have been developed in and around major cities in recent years. Most mega malls in China house food courts, restaurants, cinema halls, leisure centers, specialty stores and department stores. The malls offer a new type of shopping experience for consumers in major urban centers. In Shanghai’s shopping centers, sales growth was 14 per cent higher than the city’s overall retail sales growth in 2006. Luxury retailers have been willing to pay high rents in malls that have good locations. However, many of the recently completed mega malls, such as the South China Mall in Guangdong Province, are located in suburban areas which are not easily accessible to the average Chinese consumer. Car ownership in urban China is still very low. Consequently, a mall located far away from the city center fails to attract crowds. Many malls are too large to attract a sufficient number of retail tenants. The South China Mall is a case in point. Moreover, there are very few Chinese retail chains that are capable of becoming anchor stores of these malls. Had these malls been developed in consortium with prominent retailers or department stores, the planning, layout and utilization of these malls might have been more effective. Food and store safety In a country that has seen several scares involving disease-ridden food, the issue of food safety is critical for food retailers and suppliers. Although the government has strict rules regarding management of the food supply chain, modern retailers have invested heavily in quality control in order to avoid crises. The ability of food retailers and suppliers to maintain a reputation for food safety and quality is critical to their success. For the large hypermarket chains, food drives the traffic that enables the stores to sell non-food merchandise as well. The Chinese government has recently approved a food safety law to regulate food standards. The law mandates release of information about food safety and has provi-sions for imposing high fines on non-compliant companies. The law, which went into effect on June 1st, 2009, also
contains provisions for inspection of food exports and imports. Signaling its intent, the Chinese government launched a food safety campaign in 2007 and came down heavily on unlicensed food suppliers and restaurants. Going forward, food companies will have to be more vigilant with regard to procurement and retailers will need to obtain substantial information from suppliers before putting items on shelves. In the cases of both food and store safety the danger is that, if something bad happens, the local press will become aggressive in reporting the problem and potentially destroy the reputation of a retailer or supplier. In China, the press has been privatized and, in order to drive circulation, is aggressive in going after private enterprises (especially as they cannot go after the government with impunity). Foreign food retailers and suppliers have the advantage of being known for their safety and hygiene. Global brands can, to a certain extent and in a subtle manner, exploit this advantage in their marketing campaigns. Also, consumers in China are reputed to have a greater regard for the safety of fresh as opposed to packaged foods.
Deloitte ResearchChina’s consumer market: What next?5
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Market research One of the great challenges of operating in the Chinese consumer market lies in understanding the consumer. Traditional research techniques can yield inaccurate results. That is because consumers are often apt to provide researchers with misleading information. There is a cultural aversion to telling people things that might be offensive or embarrassing. For example, Chinese consumers might not want to offend a company by saying that they dislike their products. They might not want to admit that they cannot afford to purchase something. Such aversions will lead to inaccurate research results. Therefore, research must be conducted in less transparent ways. That is, consumers must be observed at close range. Experiments must be conducted in order to determine what works and what does not. Clearly, this kind of research is more expensive and time consuming than traditional modes. Yet it is more likely to yield robust information. Distribution Distribution in China is getting better. Anyone who has talked to business executives operating in China has probably heard a few horror stories concerning the movement of goods. Those horror stories still take place, but fewer and far between. The reason for the improve-ment is the massive investment in transportation infrastruc-ture made by the government. The result is much lower lead times. On the other hand, there remain serious problems. For example, the movement of perishable goods can be chal-lenging owing to the paucity of refrigerated trucks and distribution facilities. Thus most retailers operate localized distribution of perishables while they are starting to engage in national distribution of non-perishable goods. Carrefour, for instance, operates most of its stores as self-contained units that are responsible for their own purchases, and thus requires them to develop good relationships with local distributors. In so doing, Carrefour stores are able to customize their merchandise according to the tastes of consumers residing in each location.
Human resources In discussions that Deloitte Research conducted with global consumer companies operating in China, the issue that kept coming up repeatedly was human capital. The ability to execute a strategy is entirely dependent on the ability to find and retain good quality managers — an increasingly challenging endeavor. Companies often begin their journey in China with a large number of expatriates. Yet this is not sustainable as expats are costly and usually are eager to return home after a few years. Optimally, a foreign company in China should rely on a small number of expats and a large and growing number of local managers. Yet retaining local managers is problematic. Due to the enormous economic growth, and especially vast foreign investment, the demand for skilled managers is growing faster than the local supply. Hence, labor costs for managers have risen rapidly. Moreover, managers find that there are often new opportunities at local companies, especially after they have received valuable training from global organizations. Instilling a sense of loyalty to the company and a sense of long-term opportunity has been especially difficult for global companies operating in China. Short term financial opportunities with Chinese companies are often highly tempting. Another human resource issue is the problem of inte-grating people into what is essentially an alien culture. Foreign companies investing in China must adjust their corporate cultures to the local environment. The primary issue is one of finding the right balance between the core strengths and strategy of the company and adjusting to the needs of the local market. This is as true of human resource management as it is of merchandising.
Chinas retailing industry 
While the global economic crisis has dampened short term investment plans, most foreign retailers are planning to rapidly expand in China in the next few years. China’s retailing industry has been going through a rapid change. Until the mid-1990s, the industry mostly consisted of state-run department stores, small independent shops, and many street markets. These all continue to exist. Yet in recent years there has been a proliferation of hyper -markets, supermarkets, and convenience stores in the big coastal cities. Lately there has also been a rapid increase in the number of non-food specialty stores — both small stores that sell apparel as well as large stores selling elec-tronics, furniture, and other home related goods.
Many of the modern retail stores that have been developed in recent years are foreign invested. Such leading retailers as Carrefour, Metro, Walmart, Auchan, Ikea, and B&Q to name a few have been at the forefront of retail investment in China. While the global economic crisis has dampened short term investment plans, most foreign retailers are planning to rapidly expand in China in the next few years. It is very likely that such expansion will take place through acquisition of domestic retailers. Best Buy and Walmart have recently acquired Chinese retailers to expand their presence. Best Buy got immediate access to 136 stores across China after its purchase of a majority stake in Jiangsu Five Star Appliance. Similarly, Walmart took 101 Trust-mart hypermarkets under its wing in 2007 after it purchased a 35% stake in Bounteous Co., the parent company of Trust-mart. By 2010, Walmart plans to take complete ownership of Trust-mart.
Deloitte ResearchChina’s consumer market: What next?7
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In addition, there are now several leading local retailers in China that operate modern formats with great success. These include Lianhua, Hualian, and Wumart, each of which operates hypermarkets and supermarkets. In addition, there are some leading local specialty chains such as Gome, a large chain that sells electronics. Still, the top 100 retailers in China account for just 11.2% of total sales of consumer goods. The largest domestic retail chain in China is Lianhua. It operates close to 4,000 stores all across China. Moreover, Lianhua is now part of a larger retail conglomerate that was created through a government sponsored merger of several Chinese chains. Known as Bailian, this conglom-erate was created by the merger of Shanghai Number One Department Store, Shanghai Hualian, Shanghai Friendship, Shanghai Material Trading Centre, and Hualian Supermarket. Shanghai Friendship is the parent of Lianhua, China’s largest supermarket chain. Although this and other mergers are intended to create organizations with the large-scale efficiency to compete with global giants, there have been problems in integrating different organizations. Indeed these new giants are, to date, principally holding companies rather than large-scale retail organizations. Whether integration and centralization of processes will proceed smoothly in the future is not clear. Still, more such mergers are likely as the government would like to create organizations that have the potential to compete with global giants.
The most important modern format continues to be the hypermarket. These large stores offer food and general merchandise in an environment characterized by self service, centralized checkout, and relatively low prices. In Shanghai, hypermarkets account for more than 45% of the value of sales in the grocery sector. It could be argued that this represents over-saturation considering the current size of the market. Yet if growth continues at a strong pace the demand for such stores will grow as well. Moreover, they will continue to take market share from department stores and street merchants. Still, the lion’s share of hypermarket growth in coming years will come from development of stores in second-tier cities. Each of the major foreign players is now aggressively investing in such locations all over China. The loosening of regulatory restrictions as well as the vast improvement in transportation infrastructure made this feasible. As for the ubiquitous state-owned department stores, which continue to play a leading role in the retail indus-tries of many of Chi ’ ond tier cities, they are good na s sec candidates for future privatization. These stores are usually owned by local governments. They tend to be poor merchants, highly inefficient both in terms of supply chain management as well as customer service, and often lose money. Some have been partially privatized. In such cases, these companies have developed a variety of strategies for improvement. Some have invested in alternative formats (supermarkets, specialty stores, hypermarkets), while some have sought to become better merchants.
Consider again Parkson, the Malaysia-based department store division of the Lion Group. It has sold management contracts to Chinese department stores. In these cases, the stores are re-branded with the Parkson name and offer modern merchandising with an attractive assortment of major local and global brands.
The consumer economy  of China
In the past decade, the Chinese economy grew at an extremely rapid pace resulting in a huge increase in the number of middle class consumers. Hence the current interest in China’s burgeoning consumer market. Going forward, the long-term economic future for China appears bright. There are good reasons to believe that China’s rapid growth can be sustained for several decades. The result could be a country with a large number of affluent and middle income consumers. Why is the outlook positive? The answer is that China is in a position similar to that of Japan and Korea in past decades. That is, China is catching up to the world’s rich countries by investing in new capacity, adopting modern technologies, and consequently rapidly increasing the productivity of its workers. Maintaining the rapid growth of recent years will require several factors. These include continued investment in infrastructure, education, and public health investments that are today at the heart of the government’s economic stimulus program. In addition, rapid growth will require China’s government to accelerate the process of privatizing state-owned companies as well as allowing greater foreign involvement in China’s domestic sector. Notably, the government is now keen to shift the focus of Chinese business away from low-end export oriented production and toward higher value-added manu-facturing as well as services. In so doing, it will accelerate the shift toward a more balanced and efficient economy. On the other hand, there are two important risks associ-ated with China’s long-term growth. First, in order to sustain rapid growth, China must make a further transi-tion to a more market oriented economy. That transition is laden with risks. These include managing the necessary transition away from export oriented growth, difficul-ties associated with reforming the financial sector, social dislocation from privatization of state-owned enterprises, managing the vast migration of people from rural to urban locations, and avoiding asset price bubbles along the way. Indeed as mentioned earlier, China’s economic slowdown in 2009 is not only due to the global crisis but is also the result of the government effort in 2008 to pop the property price bubble.
China’s consumer marketFocus area of publication9