China Consumer Report 09

A Deloitte Research Study
Chinas consumer market:

What next?
2
Table of contents
1 Introduction

2 Selling consumer products in China

4 Changing landscape for distribution

7 Chinas 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
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Deloitte Research Chinas consumer market: What next? 1
Introduction
In the midst of a serious global economic crisis, in which Chinas 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 inection 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, Chinas 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 conuence 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, Chinas policymakers will probably
stimulate consumer demand, discourage saving, and encourage industries that focus on
the needs of Chinese consumers.
For the worlds 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 sufcient to drive
the growth shareholders seek. Not only are these markets saturated and increasingly
fragmented, they are not likely to grow at sufcient 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 worlds 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 nance,
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.
2
Selling consumer
products in China
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 worlds 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 afuent, 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 sufcient to simply replicate products that are sold in
afuent markets. Appropriate product innovation naturally
requires a strong understanding of consumer behavior.
Traditional market research techniques are not sufcient
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 benet
of consumer product companies.
Fourth, as millions of Chinas consumers experience
increased incomes, their incremental spending is not
necessarily geared toward fast moving consumer goods.
If a consumer becomes more afuent, they wont 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 afuent consumers and
would have to be marketed as such.
Finally, there is the issue of distribution. Chinas retail
market has become more sophisticated and consolidated
than in the past. Yet it remains relatively fragmented
compared to more afuent markets. There are countless
small independent stores, street markets, and inefcient
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 efcient,
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.
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 nancial records are
not sufciently 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 benets of
an acquisition to unravel.
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.
4
Changing landscape
for distribution
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
condent 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
neednt 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.
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 neednt pay rent.
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 Shanghais shopping centers, sales
growth was 14 per cent higher than the citys 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 sufcient 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 trafc 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 nes 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.
6
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
nd 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 nd
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 difcult for global companies operating in China.
Short term nancial 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 nding 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
Chinas 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.
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.
8
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,
Chinas largest supermarket chain. Although this and other
mergers are intended to create organizations with the
large-scale efciency 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 lions 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 Chinas second tier cities, they are good
candidates for future privatization. These stores are usually
owned by local governments. They tend to be poor
merchants, highly inefcient 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.
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 Chinas burgeoning consumer market. Going
forward, the long-term economic future for China appears
bright. There are good reasons to believe that Chinas rapid
growth can be sustained for several decades. The result
could be a country with a large number of afuent 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 worlds 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 governments economic stimulus program. In addition,
rapid growth will require Chinas government to accelerate
the process of privatizing state-owned companies as well
as allowing greater foreign involvement in Chinas 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 efcient economy.
On the other hand, there are two important risks associ-
ated with Chinas 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, difcul-
ties associated with reforming the nancial 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, Chinas 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.
The consumer economy
of China
Chinas consumer market Focus area of publication 9
10
Second, long-term growth will necessarily entail China
consuming a much larger share of the worlds natural
resources. Already this process has had a profound impact
on global commodity prices as well as a severely negative
impact on Chinas environmental quality. Although
long-term growth will require more efcient usage of
resources, it will probably have a permanent effect on
global commodity markets. This, in turn, will have geopo-
litical ramications. The manner in which China and the
rest of the world manage this process will affect growth
and stability. Indeed China has already begun to scout
the world in search of secure sources of oil and other
commodities. In addition, China has started down the path
of reducing energy subsidies that tend to discourage more
efcient use of resources.
Consumer spending
In recent years, consumer spending in China rose rapidly.
Yet it did not rise as rapidly as the overall economy and
not as rapidly as consumer income. For example, from
2000 to 2006, per capita disposable income of urban
Chinese increased 87.2% while per capita spending of
urban residents rose 74%. During that same period,
total consumer spending in China rose 74.2%. As such,
consumer spending dropped to an unusually low 36%
of GDP (compared to over 70% of GDP in the US). In the
years ahead, consumer spending is likely to rise signi-
cantly as a share of GDP as the economy restructures away
from export dependency. Thus, overall growth of consumer
spending is likely to be quite rapid.
As overall spending rose in the past decade, spending on
food fell to 35% of total spending in 2006. This was down
from 48% in 1997. Such a decline is to be expected when
an emerging country economy grows thereby leading to
greater discretionary spending power. Share of consumer
spending going to transportation, telecoms, education,
housing, entertainment, and medicine and healthcare
have increased signicantly in the last few years and will
continue to do so.
Living conditions
The shift in spending toward discretionary items and
services was related to a shift in living conditions that
resulted from a bigger economy. For example, during the
period 2000 to 2005 per capita urban building space rose
28.5% from 20.3 square meters to 26.1 square meters.
This was due to a vast increase in the housing stock, with
newer homes tending to be larger than in the past. It
also was due to a reduction in the number of people per
household. As homes got larger and incomes rose, people
could afford to purchase more durable products and had
more space in which to store them.
Interestingly, even relatively poor households enjoyed the
fruits of economic growth. For example, the share of urban
households with access to tap water increased from 63.9%
in 2000 to 86.7% in 2006. Rural households also expe-
rienced an increase in incomes and living standards. The
share of rural households with color televisions rose from
48.7% in 2000 to 89.4% in 2005.
Not only did current living conditions improve, but
prospective conditions improved as well. That is, the share
of young Chinese obtaining high levels of education rose
substantially, thereby increasing expected future earning
power. In 2006, 75% of high school students entered
college and university. Thus the next generation of urban
adults will be composed of many more skilled, middle-
income workers. The expectation of future wealth will raise
the condence of young consumers and, perhaps, make
them more willing to spend. The existence of this large
army of educated young adults is one of the reasons why
rapid future growth is expected.
In the years ahead, consumer spending is
likely to rise signifcantly as a share of
GDP as the economy restructures away
from export dependency. Thus, overall
growth of consumer spending is likely to
be quite rapid.
Ownership of durables
Chinas urban consumers now possess many of the toys
common to developed country households. This represents
a dramatic change from just a few years ago. For example,
in 2006 47.2% of urban households owned a personal
computer, up from 5.91% in 1999.
Today there are roughly 650 million mobile telephone
subscribers in China, the most of any country in the world
by far (in the US there are 260 million subscribers). This
gure is up from 269 million in 2003. In addition, there
are 117 million Chinese who access the internet from their
mobile phones, up 133% over the prior year.
More common household electronics and appliances
have been ubiquitous for somewhat longer. Since the
mid 1990s, most urban households have possessed color
televisions, washing machines, and refrigerators. Yet rural
household ownership of such products has been growing
rapidly. For example, 7.28% of rural households owned
an air conditioner, up from 1.31% in 2000. Similarly,
ownership of motor cycles, washing machines, TV sets and
stereo systems has increased rapidly since the turn of the
millennium.

Thus a large number of Chinese consumers are techno-
logically up-to-date and have access to vast amounts of
technological and cultural information. These consumers,
mostly young, are growing in number, are experiencing
the preponderance of income growth in China, and are
the most important target market for global companies
interested in China. Notably, many are starting to enjoy the
freedom of automobile ownership.
Automobiles
Chinas automotive market has seen a dramatic change
in recent years, owing in part to the large reduction in
import tariffs on automobiles following Chinas entry into
the WTO. Consequently, it is estimated that China has 35
million passenger vehicles on the road, up 164% from ve
years earlier. This number is expected to increase rapidly
in the next several years. In fact, Chinese automotive
sales in the rst quarter of 2009 exceeded those of the
US (although this was largely due to a near collapse in US
automotive purchases). In the years ahead, China will be
one of the worlds most important automotive markets
along with the US, EU, and Japan.
Although the market for automobiles in China has grown
rapidly, future growth will partly depend on the develop-
ment of a sophisticated market for automotive loans.
Further growth in automotive lending will depend, in turn,
on a more sophisticated and freer lending market. This
might entail freer interest rates (they are now government
controlled) so that lenders can price loans according to risk.
Moreover, recent improvements in the ability of lenders
to monitor and assess consumer credit will enable the
creation of a more protable automotive lending market.
In addition, the government has lately provided substan-
tial nancial incentives for rural households to purchase
automobiles.
Once automobile ownership reaches a critical level, there
will be a signicant shift in shopping behavior. Ownership
of cars enables larger transaction sizes and less frequent
shopping trips, it enables longer distance trips (such as to
out-of-town shopping centers) and enables a more diverse
range of leisure activities.
12
Spending on food
Most Chinese prepare their meals when eating at home.
Hence the market for packaged, frozen, or prepared
foods is relatively limited although it is growing. While
the yuppie population of China is rising rapidly, young
dual income professionals prefer to eat out rather than
bring a prepared meal home. For those not yet married,
they rely on a parent or grandparent to cook for them.
Consequently, when it comes to meals eaten at home, the
market for fresh foods is dominant and freshness is critical.
Thus the rise of modern food retailers in China has been
predicated, in part, on their ability to offer highly fresh
foods with hygienic conditions superior to those of tradi-
tional wet markets. Today, consumer spending on food,
beverages, and tobacco accounts for about 28 per cent of
total household spending.
Given that most Chinese have relatively small homes and
limited storage space, and given the desire to eat only fresh
foods, Chinese tend to shop frequently. Walmart says that
a typical customer comes to their stores 3.5 times per week
much more than in the US. Thus the one-stop conve-
nience of a big modern store is somewhat mitigated by the
behavior of consumers.
Eating habits of Chinese consumers, both in urban and
rural areas, have undergone signicant changes in recent
years. For example, between 2000 and 2005, per capita
grain purchases declined in both urban and rural areas
by 6.4 per cent and 16.5 per cent respectively. Instead,
milk and meat products have become a major part of the
consumption basket compared to 2000. The rise in per
capita purchases of milk and related products has been
rapid, rising from 2000 to 2005 by 80% and 170% in
urban and rural areas respectively.
Another signicant change has been the increasing avail-
ability of imported food products, mostly in stores in urban
areas. This accelerated after Chinas entry into the WTO,
which necessitated rationalization of import duties on
imported food products.
Although lifestyles have changed signicantly in urban
China, the consumption of organic foods is yet to take
off. After the United States, China has the largest area of
land devoted to cultivation of organic produce; however,
Chinas frst organic supermarket in
Shanghai had to shut down because of
poor sales. As awareness of health issues
rises with growing incomes, demand for
health foods will likely catch up.
domestic consumption of organic food is far behind that
of the US. This is mainly due to the high prices of organic
food. Chinas rst organic supermarket in Shanghai had to
shut down because of poor sales. As awareness of health
issues rises with growing incomes, demand for health
foods will likely catch up. This will open up a huge oppor-
tunity for retailers and food suppliers.
On the other hand, there is a large and growing market for
meals eaten out of the home. The success of fast food and
quick service restaurants has been notable. For example,
Yum Brands, owner of KFC, Pizza Hut, and Taco Bell,
operates over 2,000 restaurants in 280 Chinese cities and
continues to grow rapidly with strong protability. Other
Western chains have prospered in China as well. Although
these chains offer Western style food, they have adapted
to suit the tastes and habits of Chinese consumers. For
example, although pizza is far removed from Chinese food,
it has been popular because, like Chinese food, it can be
eaten family style. Yet most restaurants in China are small,
independent storefront businesses that were among the
rst to be privatized as China adopted a market oriented
economy. Thus this market remains highly fragmented.
On the other hand, there is a huge opportunity for the
consolidation of the restaurant industry. In urban China,
millions of consumers love to eat away from home in
countless, small restaurants. Many could become franchi-
sees of large global or national chain operations. This has
already begun to happen. Many more could be acquired
by larger chains. Many small, privately owned restaurants
and stores will be eager to join forces with foreign chains.
There are several reasons: rst, these companies often rely
almost entirely on internal nancing since, unlike state-
owned companies, they lack access to domestic credit. A
foreign link will enable outside nancing. Second, private
property rights are sometimes unclear. That is because, in
order to obtain credit, companies will sometimes register
as collectives and provide part ownership to government
authorities. Yet such a government link can cause problems
when selling a business or extracting prots. Thus, a rela-
tionship with a foreign company is often preferable.
Spending on apparel and fashion
The rise of a middle class, as well as a small afuent class,
is creating opportunities to sell more than just basic, low
priced clothing. Moreover changes in the rules governing
foreign investment in Chinas retailing sector are creating
opportunities for medium sized retail chains to grow
quickly in China.
Until a few years ago, foreign retailers had to have a
minimum level of capital in order to invest in China. This
effectively excluded all but very large retailers such as
hypermarkets and home improvement centers. Many
medium sized apparel chains were, thus, kept out of China.
Instead, foreign fashion brands, mostly luxury purveyors,
simply licensed their names to local Chinese companies
which opened agship stores to promote those brands.
Today, however, foreign retailers can open stores without
substantial hindrance. Consequently, many apparel retailers
based in Hong Kong and other Asian locations have
opened stores in China. In addition, many global brands
are undertaking a multi-channel approach to the Chinese
market. This includes franchising, operating their own
stores, and selling their brands to department stores. Until
recently, there were basically two types of apparel sold in
China. First, there was low priced, basic apparel sold under
14
local brand names offered in Chinese department stores,
foreign hypermarkets, or small family-owned specialty
chains. Second, there were luxury brands sold either in
franchised boutiques or upscale department stores. There
was not much in between.
Today, a middle level of apparel is developing. This involves
quality brands, both Chinese and foreign, being sold in
department stores and specialty chain stores the latter
mostly foreign operated or franchised. American Apparel
is the latest entrant into this market and plans to sell
mid-range apparels manufactured in the US. This market
includes such companies as Giordano, Esprit, H&M and
Zara. In the case of the latter, the company sees its brand
as being upscale but not luxury. It is affordable to the
middle class but at a relatively high price point. It is this
segment where considerable growth is possible in the
coming years.
The consumers who are purchasing this new middle level
of apparel tend to be Chinas burgeoning professional
class. They are relatively young, well educated, have
discretionary purchasing power and aspire to a better
life. Moreover, increasing participation of women in the
workforce translates into higher levels of discretionary
spending by Chinese women. This segment is an important
target for high-end retailers. Their sense of fashion is highly
inuenced by European luxury brands and by Japanese
styles and pop culture to a lesser extent. Hence, chain
apparel retailers tend to offer styles commensurate with
such tastes.
Aside from a prospective invasion of foreign specialty
apparel chains, the other big potential change in Chinese
apparel retailing is the privatization of state-owned
department stores. Today, these stores still account for a
sizable share of the clothing sold in China and they are
generally poor merchants. That is because they tend to
follow the Japanese model of department store manage-
ment. This involves offering branded suppliers selling space
on a concession basis. The inventory risk is borne by the
supplier and the department store is essentially a property
manager rather than a merchant. The result is a poor
mixture of styles and brands.
When privatization has taken place, it has sometimes
involved improvements in merchandising. For example,
Malaysian department store retailer Parkson has sold
management contracts to some privatized department
stores. The result is a more modern and focused shopping
experience in which brands are better showcased and
the brand mix is more rational. In the future, further such
endeavors should result in better opportunities for the
selling of global brands.
Savings
Chinese households are famous for saving a large share
of their income. As mentioned earlier, per capita urban
household income rose more rapidly than consumer
spending in recent years. The result was a large increase
in the size of per capita household savings accounts. The
value of total household savings accounts in China rose
151.1% from 6.4 trillion yuan in 2000 to 16.1 trillion
yuan in 2006. Most of that money is now held as deposits
in four state-owned banks as well as the Postal Savings
system which is expected to be privatized. In addition,
global retailers and consumer product suppliers are also
eager for those consumers to part with some of their
savings.
Honoring its commitments to the WTO, China has allowed
foreign banks to offer comprehensive retail nancial
services to Chinese consumers since the end of 2006. Not
surprisingly, leading global nancial institutions such as
HSBC, Deutsche Bank, and Standard Chartered have set up
operations in China. However, assets of foreign-invested
banks make up just about 2.4 per cent of total assets
of nancial institutions nationwide. Their gross assets at
14
the end of 2007 included US$95.1 billion in outstanding
loans. It is possible that, when the global nancial system
recovers, foreign banks will acquire smaller Chinese banks
in order to increase their reach in China. It is also possible
that Chinese consumers will be offered a more diverse
range of savings instruments including some that offer
historically higher returns. This, too, could lead consumers
to save less.
Why do Chinese save so much? Consider why people save
at all: economists believe that consumers save in order to
smooth their lifetime consumption. If they expect that their
earning power will diminish substantially in old age, they
will save in order to maintain their living standards during
retirement. In addition, consumers save in order to allay
the risk of extraordinary expenditures such as healthcare.
In urban China, pensions and healthcare have tradition-
ally been the responsibility of state-owned enterprises.
As many of these companies have been privatized, this
social safety net has been diminished. The result has been
increased saving as consumers feel more vulnerable. It
should also be pointed out that, at the time the market
economy started to be introduced in the 1980s, Chinese
consumers had virtually no savings. Thus their behavior is,
in part, an effort to catch up.
Today Chinese consumer savings is quite high for a rela-
tively poor country. Therefore the question arises as to
whether the rate of saving will decline in coming years
now that consumers have achieved a reasonable amount
of wealth. There are indications that consumption is
beginning to edge investment and exports as the leading
contributor to GDP growth. Moreover, it is reasonable to
expect that this trend will continue for a variety of reasons.
One important factor concerns the mix of urban and rural
population. Rural Chinese tend to save a higher share of
their incomes than urban Chinese because rural residents
have almost no social safety net on which to rely. As rural
residents continue to migrate to the cities, the savings rate
should decline.
Chinese must save in order to purchase big ticket items
as well as to accumulate initial payments for purchases of
homes. Yet as consumer credit becomes widely available,
consumers will be able to smooth purchases of big ticket
items thereby reducing the necessity of saving. In addition,
in the early part of this decade the government allowed
banks to require smaller initial payments for obtaining a
home mortgage. The government also made mortgage
interest payments tax deductible. These actions should
have the effect of encouraging more home ownership
and reducing the amount of saving needed in order to
purchase a home.
Finally, just the fact that millions of Chinese own their
homes should depress saving. That is because homes are a
form of wealth. If consumers expect that the value of their
homes will increase in the future, that diminishes the need
to save in order to achieve a particular level of wealth.
On the other hand, there is one important reason to expect
that personal savings in China will remain relatively high for
a long time. That is because there appears to be a strong
cultural bias toward savings. Indeed those Chinese who
possess credit cards generally do not maintain a balance
and pay off their debts as quickly as they can.
Housing and consumer credit
Chinas consumer economy is in the process of becoming
a credit driven market. Until relatively recently, almost all
consumer transactions involved cash and most consumers
held no debt of any kind. That has already changed
dramatically since 2001 when home mortgages and auto-
motive loans were introduced. Since then the market for
consumer credit has evolved rapidly. Mortgages were an
important component in the rapid privatization of govern-
ment owned housing. Increased availability of home loans
has spurred purchases of homes, leading to a threefold
increase in home prices since 1998.
Rural Chinese tend to save a higher share
of their incomes than urban Chinese
because rural residents have almost no
social safety net on which to rely.
16
Housing privatization should, over time, have two major
effects on the consumer market. First, when people own
their homes they possess tangible wealth. Economists
have long known that the tradeoff between spending and
saving is inuenced by consumer perception of wealth.
The greater the wealth, the less need to save. Moreover,
housing prices rose substantially until last year. Thus, there
are now millions of Chinese with considerable wealth and
the expectation of rising wealth. This should stimulate
more consumer spending in the future. It should also
stimulate Chinese consumers to tap into their consider-
able nancial savings for large purchases. Finally, it should
make Chinese consumers more comfortable in taking on
non-mortgage debt such as automotive loans and credit
card debt. Second, when people own their homes they
tend to spend more on their homes. This means deco-
rating, xtures, and other forms of home improvement.
It also means furniture and furnishings, electronics, and
appliances. Thus housing privatization should stimulate
spending on home related goods. Indeed, this has
happened and is the primary reason for the accelerated
investment in China by foreign home related retailers such
as Ikea, B&Q, Kingsher, and soon Home Depot.
Consumption using debit cards accounted for 21 percent
of total retail sales in 2007, up four percent from the
previous year. There were a total of 1.47 billion cards
issued by Chinese banks by the end of 2007, of which
only 70 million were credit cards a rise of 140 percent
from the previous year. In general, it is very difcult for an
average citizen to get a credit card from the banks. The
Chinese government has only recently allowed foreign
banks to issue credit cards. It is expected that, as competi-
tion between banks for issuing credit cards grows, many
banks will waive annual charges to make credit cards more
attractive to the consumers.
On the other hand, using credit for consumption is consid-
ered inappropriate in Chinese culture. This attitude among
consumers can become an impediment for the growth
of consumer credit. For example, at the end of 2007
outstanding payments on credit cards stood at only 75
billion yuan (US$ 10.4 billion), which was well below the
630 billion yuan in credit lines available in China.
A signicant development in the last two years has been
the establishment of a credit database that links all
local commercial banks and rural credit cooperatives. By
mid-2007 the database had information on 570 million
people and 12 million businesses. With access to this infor-
mation, banks can prole their consumers and make better
decisions before extending credit to consumers. Such a
system will lay the foundation of a salubrious banking
system, promote the development of a robust consumer
loan market, and encourage consumers to develop disci-
plined credit habits. This is important because, prior to
this development, default rates on consumer loans were
unusually high. This was due, in part, to a lack of informa-
tion about credit history.

Shopping for the home
As mentioned, home ownership in China has skyrocketed.
The result is a strong demand for home related products
and home improvement. Keep in mind that, when Chinese
purchase a new at in a high rise building, they are essen-
tially purchasing rooms that are no more than empty
concrete boxes. Everything else must be added by the
owner including plumbing, electrical wiring, shades and
curtains, bathroom and kitchen xtures and appliances,
and ooring. Thus, the market potential is considerable.
Although several foreign and domestic home improve-
ment retailers have opened stores in China (Kingsher, Obi,
Home Way, Home Depot), about 80% of home improve-
ment spending still involves less efcient channels. For
example, in most big cities in China, there are neighbor-
hoods where the businesses specialize in home improve-
ment. Entire blocks are devoted to small, independent
shops that each offer particular products and brands
(pipes, kitchen xtures, baths, etc). Consumers must go to
a wide range of stores in order to put together the compo-
nents for a project. They then hire laborers to perform the
work as do it yourself is not part of Chinese culture
especially given the low cost of labor.
So what is the competitive advantage of a big home
improvement center? These modern stores are targeted
at educated professionals who are pressed for time and
enjoy the convenience and quality of modern shopping
processes. These consumers are also brand conscious
and appreciate the selection of premium brands found
at modern stores. Moreover, they may also appreciate
the authenticity of such brands at modern stores given
the high level of counterfeiting that takes place in China.
Finally, these consumers appreciate the reliable information
that can be obtained from the service staff at such stores.
Given the low cost of labor, modern home improvement
stores can offer a large number of well trained staff to
assist shoppers in planning projects. For example, each
B&Q store in China has a design center where designers
help customers make the right decoration choices for their
homes. Some stores have also started selling electronics
and home appliances to offer a comprehensive range of
products for the home.
Given these competitive advantages, the market share
of modern retailers is expected to rise rapidly in the next
few years as retailers invest in expanding. Moreover, in
coming years as the secondary market for houses develops,
consumers will look towards one-stop home improvement
stores to make wholesale changes to existing houses.
Attitudes toward brands
Chinese consumers appear to have mixed attitudes toward
brands. When it comes to luxury products or products for
which quality is perceived as highly important, consumers
are highly brand-conscious. Thus luxury brands are sought
after when purchasing apparel, footwear, jewelry, or
cosmetics. When purchasing home-related products,
brands are important as well. Chinese consumers prefer to
spend more on a known brand name for such products as
kitchen and bathroom xtures, appliances, house wares,
and furniture. All of these are products that may be seen
by others. Thus the status of the brand is critical.
On the other hand, for many packaged goods that have
commodity-like appeal, and which friends and neighbors
are not likely to see, brands hardly matter. The ability of
some packaged goods suppliers to create strong brand
identity and loyalty is, therefore, quite notable.
The fact that premium brands in fashion and home
goods are so popular in China is one of the reasons that
counterfeit goods have become such an important issue.
Counterfeit items enable consumers to obtain the best
brands without having to pay premium prices. Moreover
counterfeiting, both for the domestic and export markets,
has become a huge industry in China. Although senior
government ofcials have expressed concern about the
issue, combating piracy is difcult due to the massive
infrastructure already in place. In addition, the industry is
often protected by local law enforcement. For producers
of branded products, this is one of the biggest obstacles
to doing business protably. In the last few years, courts in
eastern China have passed some key judgments to protect
foreign manufacturers intellectual property. In addition,
the Chinese government has developed a national policy
on intellectual property rights.
Finally, there is the issue of Chinese versus foreign brands.
This is a complex issue because attitudes have changed
over time and are different depending on the type of
product. In the early days of economic reform in China,
foreign brands were generally preferred as Chinese
consumers recognized the inferior quality of state-
produced products. Yet as the economy developed, state-
owned companies were privatized and many became much
better producers. Pride in the nations accomplishments
compelled some consumers to prefer local brands, all other
things being equal.
Today, a more sophisticated consumer appears to be
relatively ambivalent about this issue. While nationalism
is a strong political attitude, when it comes to business
consumers have become comfortable with the nations
achievements. As such they dont feel the need to support
local brands in order to promote their countrys interests.
So while Chinese retailer Lianhua emphasizes its Chinese
roots, many analysts attribute the companys success to
Pride in the nations accomplishments
compelled some consumers to prefer local
brands, all other things being equal.
18
good management rather than national pride. The impli-
cation is that foreign brands should not necessarily be at
a disadvantage in China. Indeed some observers believe
that Chinese consumers regard foreign brands as generally
having higher quality. If so, consumers will be willing to pay
a price premium for a foreign brand.
There are products and services for which foreign brands
will have a natural advantage, while there are those for
which no such advantage exists. It makes sense for foreign
companies to avoid those products where they lack any
advantage over Chinese companies. For example, foreign
makers of rice noodles might have difculty developing
brand equity with local consumers given the availability of
well regarded and venerable local brands.
Regionally, there is wide variation about brand percep-
tion across China. For example, in the northern region of
China appearance and status are key drivers of spending
on luxury goods. In the eastern region, where disposable
incomes are high and the workforce well educated, there is
a strong demand for the latest offerings of leading inter-
national brands. This is less so, however, in the central and
western regions.
Attitudes toward price and quality
Chinese consumers are price sensitive, of course. Yet as
the discussion about brands indicated consumers are quite
concerned about other attributes of a product or service
and will often pay a premium price.
Yet brand name is not the only attribute that concerns
Chinese consumers. They also value customer service
(despite or because of its paucity in China), entertain-
ment, and community involvement. For example, Yum
Brands, operator of KFC and Pizza Hut restaurants in China,
employs four to six people per restaurant for the purpose
of developing community relations. These people interact
with children and the elderly and organize community
events. The goal is to convey the impression that these
restaurants are an integral part of the community. Of
course given the low wages in China, doing such outreach
is more affordable than would be the case in the US or
Europe.
Income distribution
As a nominally Communist country, China is expected to
have a relatively even distribution of income. Yet China has
a de facto capitalist economy which, although it produces
rapid growth, possesses many of the vices and inequi-
ties typical of a market economy. This includes growing
inequality of income and living standards. Specically, there
is a sizable gap between the lifestyles of rich and poor,
urban and rural, coastal and interior.
Government leaders have expressed growing concern
about this gap and have proposed policy measures aimed
at reducing the gap and alleviating its social effects.
In November 2007, the Ministry of Commerce revised
the Catalogue for the Guidance of Foreign Investment
Industries in which it dropped the article limiting foreign
investment in central and western regions of China. This
will help these relatively backward regions catch up with
the prosperous coastal region of China. On the other hand,
the high standard of living of Chinas top earners offers a
signicant and growing opportunity for global consumer
business companies.
Consider a few facts. First, the per capita income of the
top 10% of urban households in 2006 was 9 times that
of the bottom 10% and 3.15 times that of the middle
quintile. The per capita living expenditures of the top 10%
of urban households, however, was 6.15 times the bottom
10% and 2.66 times the middle quintile. These lower ratios
reect the fact that higher income households tend to save
a much larger share of their incomes.
The gap in income levels is also reected in ownership of
major durable products. For example, in 2006, for the top
10% of urban households there were 20.11 automobiles
per 100 households. Among the bottom 10%, there were
almost no automobiles. Even among the middle quintile,
there were 1.9 automobiles per 100 households. Similar
differences exist for many other durable products. For
example, 91.3% of the top 10% of urban households
owned a personal computer in 2006 while 47.2% of all
urban households owned a computer.
Regional differences
The inequality in income and living standards in urban
China roughly corresponds to geographic differences. The
major coastal cities such as Shanghai, Beijing, Guangzhou,
and especially Shenzhen were the rst to experience
market oriented reforms. As such, they grew faster over
the past 20 years than most other parts of China and have
emerged relatively afuent.
For example, average disposable household income in
Beijing is roughly US$3,000 at current exchange rates, not
far below the average for the top 10% of urban house-
holds nationwide (US$5,000). The national average for all
urban households is roughly US$1,678. Consequently, it
is reasonable to infer that the top 10% of households in
Shanghai, Beijing, and Guangdong have very high incomes
by Chinese standards. If Shanghais income is distributed
similarly to the national pattern, then the top 10% of
Shanghai households has an average income of US$15,000
at current exchange rates. Using an exchange rate that
measures the true purchasing power of the currency, this
would translate into an average purchasing power of
approximately US$60,000 per household.
There are also big geographic differences in the way that
Chinese spend their money. In Shanghai, people spend far
more than the national average on food, housing, recre-
ation, transportation, and communication. Yet interestingly,
Shanghai residents are much less likely to own an automo-
bile than residents of Beijing or Guangdong Province. Some
geographic differences in spending may be due to differ-
ences in regional prices. For example, housing in Shanghai
is far more expensive than in many other provinces.
Indeed, given such differences in the cost of living, the
relative afuence of Shanghai may be overstated.
Not only are there differences in income between the
coastal and interior regions, there are also differences
within urban centers. In the big coastal cities that have
experienced breakneck growth in the past two decades,
poorer citizens have been pushed to the periphery as
home prices near the center have skyrocketed. The result
is not unlike other cities the world over. The afuent live
close to the center of things and lower income households
populate the edges of the cities. Indeed housing designed
for lower to middle income consumers is growing on the
outskirts of big cities. Big discount retailers are following
consumers to these locales.
Finally, regional differences are not simply about money.
China is a highly diverse nation, with many languages, life-
styles, types of food, and business styles. Companies doing
business in China must take account of these differences
when choosing product and service mixes as well as when
managing local enterprises.
In addition, China is not a single entity when it comes to
doing business especially consumer business. After all,
during the period prior to market-oriented reforms (the
communist era), each city in China was relatively self-
sufcient economically. Local factories produced consumer
goods under local brand names and distributed locally.
Thus consumers became accustomed to local brands
and distribution was highly fragmented. Although this is
starting to change, especially with the construction of a
national transportation infrastructure, consumer business
remains highly localized. To the extent that there are
national consumer brands, they are mostly global brands or
private labels of global retailers. China remains at the early
stages of developing a national consumer goods distribu-
tion system.
What does this mean for global retailers and branded
suppliers of consumer goods? It means that business must
be organized around local distribution. Hence a retailer
operating in several cities must deal with different local
distributors for the same product. Retailing remains highly
fragmented and primarily local, so branded suppliers must
deal with thousands of different major retailers in each
local market. This localization retards the ability to develop
large-scale efciency. Still, as the transportation infrastruc-
ture develops, and as national retail organizations develop,
the distribution system is gradually shifting toward a
national model.
20
Demographics
Chinas population growth is relatively slow. Over the next
20 years the population is only expected to increase by
11% to about 1.45 billion. Yet, given Chinas large popu-
lation, this represents an increase of 147 million people,
or more than the population of Japan. More interesting,
however, is the way in which the age distribution is
expected to change. Because of declining fertility rates and
delayed marriage and childbirth, the number of children
and young adults will decline considerably. The under 20
population will drop by 49 million over the next 20 years.
In addition, the number of young adults (ages 20 to 34)
will decline by 42 million. On the other hand, the number
of middle aged adults (ages 50 to 64) will increase by 134
million or 73%. The number of elderly (over 65) will double
from 99 million to 199 million.
The trends noted above are already well under way. In
just the past ve years, it is estimated that there has been
a dramatic shift in the age composition of the population
owing to rapidly changing rates of fertility. For example,
the under 20 population declined by 22 million from 2000
to 2005 while the 20 to 34 year old population fell by 25
million. Meanwhile the older cohorts have experienced
large increases.
Finally, among children and young adults there is a large
disparity between the numbers of males and females. For
example, in 2007 there were 46.7 million males aged 5
to 9 while there were only 40.7 million females in that
age group. Similar differences exist for many other young
cohorts. This unusually large gap is due to the one-child
policy followed over the past generation. The desire for
sons led many Chinese families to undertake measures
aimed at assuring male births. This gender disparity could
have signicant implications for lifestyles of adults in the
future. Moreover, it could have an adverse impact on
social stability and crime as a large number of men fail to
nd permanent mates. Finally, it is widely believed that a
relative dearth of young females will exacerbate the low
rate of fertility.
What do these demographic trends augur for consumer
business in China? First, the absolute decline in the number
of dependent children means that there will be far fewer
households in which children are present. This implies less
spending on child and teen related products (clothing,
toys, and games). It also implies that there will be more
money available for adults without children to spend on
themselves. Those adults who dont have children or delay
having children will likely spend more on eating out, deco-
rating homes, travel, and entertainment.
Second, the increase in the older working age population
(50 to 64) has important implications. This age group tends
to save more and spend less. It tends to spend more on
services and less on goods. It also tends to spend consider-
ably on grandchildren.
The huge increase in the number of elderly Chinese will
have vast implications for many industries including
healthcare, pharmaceuticals, recreation, fashion, home
furnishing, and food service to name a few.
China and the internet
As in many developed countries, the growth of internet
usage in China has been phenomenal. What makes Chinas
experience exceptional, however, is the fact that China has
so many people. Consequently, the numbers involved are
sufciently large to attract the attention of many of the
worlds leading internet sellers. Such venerable US internet
companies as Microsoft and Google are highly active in
China. These and many other companies have ambitious
plans for future growth in China.
By the end of 2007, there were 210 million internet users
in China, which can now boast of having the second
highest number of internet users in the world after the
United States. Internet usage increased by 53 per cent in
2007. However, with only 16 per cent of its population
online, the Chinese are still below the world average of
19 per cent. An important caveat is the fact that only a
fraction of Chinese internet users own a PC. A majority of
them throng internet cafes in order to access the Internet.
The number of broadband internet users in China reached
163 million in 2007, which is 86 per cent of all the internet
users in China. According to the China Internet Network
Information Center (CINIC), 55 million of Chinas internet
users shopped online last year with the total value of their
transactions amounting to almost 60 billion Yuan (approxi-
mately US$8.2 billion). It is estimated that this grew to
US$13.4 billion by 2008. At present, online sales account
for less than one percent of total retail sales, but CINIC
predicts that this gure will rise to between ve and eight
percent by 2012.
The recent boom in the number of internet users has
created a market of signicant size for consumer oriented
companies. They can reach out to their consumers directly
either by selling their good and services online or by adver-
tising online to create product awareness. Online adver-
tising would also serve as an incentive to create world-class
Chinese portals.
According to CINIC, 40 percent of the new users in
2007 resided in rural areas. With a sizeable chunk of
new internet users concentrated in the rural areas,
there is a completely new market opportunity awaiting
companies. Increased internet usage in rural areas will
enable consumer oriented businesses to reach out to these
consumers without necessarily having a strong physical
presence in those areas.
Although it is clear that the internet will rise in importance
in the years to come, there are several issues that will
determine the success of internet commerce. These include
the reliability of the postal service, the ubiquity of credit
and debit cards, and the degree to which store retailers
will play a role in the distribution of goods ordered online.
Retailers will need to build and promote secure portals
to encourage internet users to shop online. This would
require them to add a completely new IT department to
their operations. So far, very few have done so. PPG is an
exception, which has been very successful by selling mens
shirts to consumers online.
Ultimately, the rise of consumer credit in China will
increase online spending over time as will the advent of
3G mobile phone capabilities by improving internet speed
and accessibility for Chinas vast army of mobile phone
users. Meanwhile, the rise of online pay systems has
enabled consumers without credit cards to shop online.
For example, Alibabas AliPay system has been a notable
success in China. It requires the purchaser to put money
into an account. The seller afrms that there is sufcient
money for the purchase and sends the goods to the
consumer. The account is now held in escrow by AliPay.
The consumer receives the goods and, if satised that this
is what was ordered and the quality is good, releases the
funds to the seller.
Finally, Chinese consumers are concerned about the quality
of the products they purchase online as they are not
able to assess them in person. This suggests that strong
brands will fare much better in an e-store. Going forward,
manufacturers and retailers will have to be very cautious
and transparent with respect to the quality and pricing of
their products. At the same time, by revealing consumer
preferences and behavior, internet usage data can help
companies to better plan and time their marketing
activities.
Chinas consumer market Focus area of publication 21
22
Short term
economic outlook
When the global economic crisis of 2008-09 began, it was
widely expected that the big emerging markets would be
somewhat immune to the full impact of the downturn.
The conventional wisdom was that these countries had, to
some extent, decoupled from the West. That is to say, they
had become less dependent for their growth on exports to
the US and Europe. They were more dependent on other
emerging markets as well as their own domestic demand.
There was, indeed, truth to this view. Yet, although
emerging markets such as China had indeed become less
dependent on the West, they remained dependent none-
theless. Hence, when the crisis came, it wreaked havoc
with emerging markets.
In the case of China, its economy was already set to slow
down due to the lagged effects of a tightening of credit
by the central government. This was undertaken in order
to pop a property price bubble as well as suppress ina-
tionary pressures that had begun to be onerous. In other
words, Chinas economy had started to overheat. Then,
when the global crisis took hold, China was hit by a sharp
drop in demand for its exports. The result was a marked
slowdown in growth, led by a sharp drop in exports. From
a human perspective, this has meant the shutting down
of thousands of factories and the dismissal of millions
of workers. The government reported that roughly 20
million migrant workers lost their jobs at factories in the
big coastal cities. Many have returned to their rural and
inland villages. Thus, a reversal of a long-term rural-urban
migration has taken place.
Yet, despite this sharp reversal of fortune, Chinas
consumer market has remained surprisingly robust with
retail sales rising at a strong pace. Why is this? There are
several reasons. First, job losses have largely been conned
to low wage workers in coastal factories. Yet a dispro-
portionate share of retail spending is undertaken by the
middle class and afuent consumers who work in Chinas
services sector. These consumers have not, by and large,
experienced large job losses.
Second, the scal stimulus undertaken by the govern-
ment to counter the loss of export demand is having a
positive impact on domestic demand. Moreover, it is being
funneled substantially into healthcare and education. The
need for consumers to spend on these categories has
generally led them to save heavily as a precaution. It is
hoped that more government spending on these catego-
ries will discourage such saving.
Third, the existence of a massive pool of consumer savings
means that, even in a period of economic uncertainty,
consumers feel comfortable maintaining their level of
spending as they can, if necessary, dip into their savings.
Finally, consumer prices in China are now stable while
house prices have fallen. Moreover, an easing of credit
conditions by the monetary authorities is boosting
demand. All of these factors are playing a role in stimu-
lating consumer spending.
It is expected that China will recover quickly from its
doldrums and that economic growth will resume at a rapid
pace. As Chinas economy recovers, consumer demand is
likely to be very strong.
Strategic requirements
for success
What are the requirements for success in the Chinese
consumer market? Based upon examining the experi-
ences, both positive and negative, of numerous consumer
oriented companies in China, this brief and incomplete list
of success criteria is offered:
Employ good local managers
This is a necessary condition for success. Even if all other
aspects of a business are correct, the absence of good
managers will condemn the investment to failure. Yet this
is highly challenging. The demand for good managers in
China is growing faster than the supply. The result is that
the cost of managers is rising. Yet more onerous is the fact
that the ability to retain good managers is declining. After
obtaining training, a good manager will often be vulner-
able to the pecuniary offerings of rival companies. The
question arises, then, as to how to induce loyalty without
paying ransom. There is no easy solution. Still, an effort
must be made to instill a sense of long-term involvement
and opportunity with a company. Some foreign companies
operating in China take their managers on trips to the
home country to obtain both training and a sense of
esprit de corps. Managers must feel that the company
has good prospects and that there are long-term career
opportunities.
Invest for the long-term
Success in China does not usually happen overnight. It
requires painstaking attention to detail and the develop-
ment of a local organization that is integrated into the local
culture and business environment. It often entails much
trial and error. Any decision to operate in Chinas consumer
market must entail the expectation that returns will be
substantial, but will take time to reap. It is notable that
many Japanese companies send executives to China with
the expectation that they will stay there until retirement.
Western companies, on the other hand, often send execu-
tives for temporary tours of duty. While a lifetime commit-
ment is not necessarily the answer, a sense of long term
expectations is entirely appropriate.
Stay true to core competencies (which are not easily
dened)
It is a mantra of business schools that companies must
focus on their core competencies. Yet when investing in
China (or any other emerging market), this is not a trivial
issue. After all, it is not always a simple matter to identify
the core competency. Take the KFC division of Yum Brands,
for example. In China, KFC restaurants offer a considerably
different menu than in the US. Clearly it is not fried chicken
that is the core competency. Instead, it is the ability to
manage a large restaurant chain. Dening the core compe-
tency is critical when fashioning a business strategy for the
Chinese consumer market. Companies must ask themselves
the following questions: What do we offer consumers that
will attract them? How are we different from potential
competitors? What can we do well in China and what can
Chinese companies do better?
Recognize and adapt to unique cultural differences
While staying true to core competencies, companies
investing in China must also adapt to the needs of the local
market. Naturally this includes adjusting the mix and attri-
butes of the products and services sold. Yet it also entails
adjusting to the business culture of China or rather the
many business cultures of China. After all, China is a fairly
diverse country, with many dialects and many different
cultural attributes. For example, some companies operating
in China have indicated that customers and managers are
quite different in Beijing than in Shanghai. These differ-
ences can involve work habits, attitudes toward customers,
shopping behavior, and receptiveness to marketing
messages. Companies must take account of these differ-
ences when developing a strategy.
24
Concluding thoughts
Chinas consumer market has the potential to account
for a disproportionate and signicant share of growth
for the worlds leading consumer oriented companies in
the coming years. The challenge will be to navigate the
risks and obstacles of operating in the Chinese market
while taking full advantage of the opportunity that rapid
growth is creating. This will entail exploiting a companys
best features while adapting to local needs. It will entail
extending a companys culture to a new environment by
integrating local managers into that culture. Finally, it will
entail creating a truly Chinese organization with mostly
Chinese managers who are loyal to the company and
intend to make a career to building the business.
24
Author
Dr. Ira Kalish
Director, Global Economics
Deloitte Research
Deloitte Services LP
USA
Tel: +1 213 688 4765
e-mail: ikalish@deloitte.com
Contributor
Vinay Hukumchand
Senior Analyst
Deloitte Research
Deloitte Support Services India
Private Limited
USA
Tel: +1.615.718.5150
e-mail: vhukumchand@deloitte.com
U.S. Industry Leaders
Consumer Products
Pat Conroy
Deloitte LLP
Tel: +1.317.656.2400
e-mail: pconroy@deloitte.com
Retail
Stacy Janiak
Deloitte LLP
Tel: +1.612.397.4235
e-mail: sjaniak@deloitte.com
Chinese Services
Clarence Kwan
Deloitte LLP
Tel: +1.212.436.5470
e-mail: clkwan@deloitte.com
Global Industry Leaders
Consumer Business
Lawrence Hutter
Deloitte MCS LLP
UK
Tel: +44 20 7303 8648
e-mail: lhutter@deloitte.com.uk
Chinese Services Group
Lawrence Chia
Deloitte Touche Tohmatsu
Hong Kong
Tel: +1 852 2852 1094
e-mail: lawchia@deloitte.com.hk
John Jeffrey
Deloitte LLP
USA
Tel: +1.212.436.3061
e-mail: jjeffrey@deloitte.com
Contact information
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