Chinese Nokia factory

Special Report: Inside China - Navigating the markets

How can foreign firms overcome the myths and fantasy, and reach that rare bird - the Chinese consumer?

by Charlotte Butler and Michael Backman, World Business
Last Updated: 23 Jul 2013

China's markets have long been a riddle to foreign firms. In theory, they present a target of over a billion consumers, but in practice few foreign firms have been able to boast high returns and many have retired after suffering years of loss.

In 2003, the estimated profits of US companies in China were just $4.4 billion, similar to those from Australia. No country has attracted more hyperbole than China, and nowhere has the gap between potential and actual returns been greater.

Unfortunately, what many failed to notice was the fact that China's per capita GDP is still ranked lower than 100th in the world and of the 1.3 billion Chinese, only 400 million are urban consumers, mainly found in the rapidly growing and urbanised east. Shanghai, for example, is an urban conglomeration as big as Los Angeles, with 18 million inhabitants.

According to Gallup surveys, incomes in China's top 10 urban regions are more than five times those in its vast rural interior - and the gap is getting wider every day. More than three-quarters of a billion Chinese exist in poverty without the means to buy expensive Western goods. Not surprising then, that Western firms found the bottomless markets of their dreams singularly elusive.

Of course, their calculations were not completely based on a myth. Since 1979, the Chinese economy has been expanding at an average annual rate of 9.6%. Revised data released in December 2005, which included activity in the services sector for the first time, put China's GDP for 2004 at $1.98 billion, making it the world's sixth biggest economy.

But one of the first rules about China is never trust government statistics. One economist has described the original official 2004 statistics as a "fantasy world" and another observer noted that "one cannot help but feel exasperated by the opacity of the National Bureau of Statistics' operations, and the frivolity with which the NBS seems to treat its numbers". Lies, damned lies and statistics, but in China it is mostly the first two.

So what is the truth behind the Chinese mirage? Which markets actually exist and how can you reach that rare bird, the Chinese consumer? Here are some tips for success:

Expect the unexpected: In China, perhaps more so than in other parts of the world, markets are hard to control and predict. Under the force of the competition they attract, they can go from opportunity and rapid growth to over-capacity, bitter price wars and collapse in a short time, so flexibility and vigilance are vital. In many, the easy money has already been made and with profit margins declining, things can only get harder.

Although it involves very real difficulties, consider moving into the more remote areas. Being further from Beijing and therefore less favoured, these provinces are more likely to offer you a better deal and give you support, as they are keen to attract foreign investment. Also, the local competition may be less fierce. As long as you do your research thoroughly and get a good logistics partner, the market may turn out to be a winner.

Clear your mind of all the hype: Go back to basics and do a classic marketing strategy exercise. Look at the external and internal environments; list the threats and opportunities, your strengths and weaknesses. Ask every question you can think of: can we be competitive? Can the product be competitive?

Will it make money? Is anyone making any money? Study the local competition.

Would any of them make a good partner? It might be easier to sell a service than a product, since services are more difficult to copy. Also, remember that emerging markets are just that and in China as in every other country, new segments are developing all the time as industries expand, salaries rise and spending power increases.

Don't go for a blanket market approach: Try to identify a segment with unfulfilled needs. The more tightly defined the segment, the better your chance of success. Try segmenting by age, gender, household income and size, education or occupation, or by the three Rs - religion, race and region. Remember, more than two-thirds of the population live in the countryside and still have a 'collective' mentality.

Remember your Ps: Price, Place, Promotion and Product. China is no different from any other market, so you need to understand your customers, tailor your product and make sure it is efficiently distributed and promoted.

Although price is still important, there has been a growing trend among middle-income shoppers to put quality before price. A recent survey also found that brand awareness was growing and would be the next most important factor for the richer segments, followed by price, packaging, advertising and promotion. If you missed out on a market the first time around, consider the replacement market.

Invest in sectors where you have world-class capabilities, or where the government wants to push growth; for example, the energy and infrastructure sectors. Taiwanese chip manufacturers, not normally the most welcome entrants to mainland markets, have found their expertise greatly in demand to feed the growth of China's semiconductor industry. They have traded their technology for access to a fast-growing market. However, in order to guard their advantage, they are transferring only mature technology. Similarly, retailer Carrefour used its logistics and back-office superiority to build up a lead and become the only profitable foreign supermarket chain in China.

Start small and build according to demand: Ignore the hockey stick forecasts supplied by local managers and you won't be left with a warehouse full of unwanted products. Remember, you don't have to rush in. If conditions are not right, then wait. In 2005, UK department store Harvey Nichols said that China would not be ready for entry for another two to three years, as the rich were buying only major brands and were not yet the sophisticated luxury goods shoppers the store would attract.

THE CHINESE CONSUMER

According to a report from Credit Suisse First Boston* published in 2005 - one of the largest surveys of consumer attitudes in China - household consumption spending in 2005 was 3.8% of the global total. China is expected to overtake Italy this year and France by 2007.

The findings indicate that middle-class households - public servants, academics, teachers, doctors, engineers, white-collar workers of all kinds - have incomes of at least $10,000 per annum, the lowest income at which people can afford both an apartment and a small car, and the expansion of glossy car magazines demonstrates that car ownership is a priority. With increasing wealth, these consumers will also seek to upgrade home appliances and buy more expensive goods such as LCD screens, PCs and telephones. Education is also highly ranked and savings rates remain high.

The pampered youth market, a product of the one-child policy, is identified as the most brand-conscious and receptive to foreign products. When Sony discovered that its products were seen as more attractive to older people, it redesigned its MP3 specifically for the youth market. It is predicted that the young will remain the largest consumer segment until 2014, after which growth is expected to slow as demographic trends kick in. The total population is forecast to hit 1.31 billion in 2019 and decline rapidly thereafter.

The reports suggest that the number of people under the age of 40 may already have peaked at 800 million and could decline by a third over the next 20 years. By 2024, the 'oldies' will make up 58% of the population and by then 75% of Chinese households may be childless.

Increasingly, the 40-60-year-old group will have the most purchasing power, which it is expected to spend on travel, eating out and financial services Looking ahead, the older, retired generation will take over as the largest segment. Their history - having lived through the last years of Maoist socialism and the Cultural Revolution - means they are much more abstemious.

As their tastes are dictated more by practicality than luxury, they are more likely to be concerned with health and environmental issues. Some firms are already responding to these concerns.

More research will undoubtedly emerge as companies try to anticipate how they can appeal to the different segments of consumers. And don't forget future generations: China adds the equivalent number of inhabitants of Australia (20 million) to its populace every year. Maybe your key market hasn't even been born yet.

*The Rise of the Chinese Consumer, Jonathan Garner, Vincent Chan and Marisa Ho, Wiley, 2005

GO WEST, YOUNG MAN

Foreign firms are looking to the hinterland for investment prospects, encouraged by a central government concerned to avoid rural unrest (87,000 riots in 2005). The government's Great Western Development Policy, announced in its Tenth Five-Year Plan (2001-05), offered tax breaks and other incentives such as cheap land and bank loans to firms investing in the poorer inland regions of the north-east and west of China.

Many companies, including Whirlpool, Intel and, perhaps most surprisingly, Gucci, have taken up the challenge. A popular destination is the western province of Sichuan, whose capital, Chengdu, calls itself 'the Shanghai of western China'.

The move makes good sense in view of the labour shortages, and rising wage and land prices that are pushing up costs in the urbanised Guandong Pearl River Delta, Fujian and Zhejiang provinces and Shanghai. Other companies moving there include BP, Ford Auto, Alcatel, Corning, Ericsson, Microsoft, Motorola, Nokia and South Korea's SK Teletech. However, there is still only a trickle of foreign direct investment - a mere $2 billion between 1999-2004, half that going into Shanghai alone.

Take note also that heading west means start-up costs can be high if you have to put expat managers into hotels for long periods, and that training local workers will be tough. It will also mean longer supply chains and dealing with the biggest barrier of all: a lack of infrastructure.

Logistics costs in China represent more than 20% of GDP compared with 10% in Europe. Local governments often maintain inefficient supply chains to protect local jobs. B&Q has 1,800 suppliers for 48 stores in China compared with 600 suppliers for 300 stores in the UK.

Although the road network is reasonably efficient, the rail network is undeveloped and river transport slow. In the west, the Yangste river is the main transport link to Chongqing, the major inland port. Not surprisingly, western logistics providers such as APL Logistics, UPS, DHL, Maersk and TNT have been quick to seize the opportunity and move into a market currently estimated at only about $1 million-$1.5 million, but growing fast. UPS, which paid $100 million to take full control of its joint venture in 2005, and TNT, already present in 600 Chinese cities, are both on the acquisition trail.

However, foreign firms that do move west risk finding a rerun of all the problems that dogged early entrants into eastern China and the coastal regions - red tape, bureaucracy and corruption.

This is an edited extract from Big in Asia: 30 strategies for business success, Michael Backman and Charlotte Butler, Palgrave Macmillan, 3 November 2006, £19.99, ISBN: 0-23000-027-4

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