Ready for Warfare in the Aisles
For
both domestic and foreign retailers, China is a market of unprecedented
opportunity. But it is turning into a battleground
Imaginechina
TIRED
after a long day helping to propel the world's most dynamic
economy to new heights? Then relax under a luxury duvet, filled
with the chest fluff plucked from 3,000 Icelandic wigeon, priced
at a mere 110,000 yuan ($14,000) and lighter than the bag it
comes in. Sam's Club in Shenzhen, China's richest city, sold
its entire stock of three (only 50 are made each year) during
the Chinese Spring Festival. Or choose a solid gold bottle of
baijiu liquor for the equivalent of $11,000 or a 65-inch television
for $15,000. It is not so much the high prices that are surprising,
but that the Shenzhen superstore is part of America's giant
Wal-Mart, which is famous for selling Western consumers cheap
goods made in China.
Luxury
puts the shine on Chinese retailing, although the business is
mostly about selling more mundane things. Hence the Shenzhen
Sam's Club also stocks gallon drums of cooking oil, plastic
cups and other everyday items at rock-bottom prices. The sprinkling
of expensive stuff among the bargains says much about the aspirations
of modern Chinese consumers, as well as the heroic efforts of
the world's retailers to win a share of their wallets. The scramble
to open stores has made China a paradise for shoppers, but for
shopkeepers it has become a brutally competitive market in which
only the strong will survive.
Enormous numbers are luring global retailers to set up shop
in China and take on a growing band of local operators. China's
retail sales are set to expand by 13% to the equivalent of $860
billion this year, making the mainland the world's seventh-largest
retail market. Annual compound growth rates of 8-10% will push
this to an enormous $2.4 trillion by 2020.
Here
comes the middle class
There are more than one million affluent urban households, earning
more than 100,000 yuan a year, who regularly buy luxury goods.
But their spending power is rapidly being dwarfed by a vast
emerging middle class. These households earn between 25,000
yuan (the threshold for becoming a serious consumer in China)
and 100,000 yuan, says McKinsey. The consultancy estimates that
the number of such households will rise from 42m in 2005 to
200m by 2015 (see chart 1).
Stores
like the one in Shenzhen show how much has changed in Chinese
retailing. Just two decades ago, shops had surly staff offering
a few drab items, often locked safely away in glass cases. Yet
there is still a long way to go. Even today, much of the population
buys from daily markets or directly from producers. Organized
retailing remains relatively new. Most Chinese stores are tiny,
family-run outfits. China's top 100 chains account for just
a tenth of total retail sales.
When China's economic reforms began, state-owned department
stores, such as Dalian Dashang and Wangfujing, dominated. Only
in the late 1990s did specialist supermarkets and electronics
and home-decor chains emerge. Yet even the largest is not national.
Local protectionism raised bureaucratic hurdles to moving goods
across provincial borders. Many constraints remain, says Joe
Hatfield, the president of Wal-Mart Asia, who has spent 12 years
working in China. With few national retailers and national brands,
economies of scale are hard to achieve. Most retailers use a
myriad of small suppliers operating through wholesalers. This
raises costs and lowers efficiency.
Yet
the arrival of foreign retailers is changing things. Apart from
Wal-Mart, other successful giants have set up shop, including
France's Carrefour, Britain's B&Q and Malaysia's Parkson.
Foreign firms now account for 23% of the sales of the top 100
food retailers in China. More are arriving with the lifting
of rules restricting foreign chains to a handful of big cities.
In 2005, over 1,000 new retailers received approval, of which
more than half had foreign investors. There are now over 1,000
foreign retailers in China compared with just 314 two years
ago.
Local
rivals have responded ferociously. Crippling price discounts
can be accompanied by dirty tactics: some stores send fake "customers"
to rivals' new stores to snap up all the promotions before genuine
customers can get them. Another trick is to jam the doors of
the lockers used by shoppers to store their purchases. Meanwhile,
retailing costs are rising. As China urbanizes, commercial-property
prices are soaring and retailers face a doubling or tripling
of rents on renewal. Marketing expenses are also growing. Between
2002 and 2004, advertising spending rose by 50% a year across
all categories of consumer products in China. And wage growth
is outstripping productivity gains.
Product
prices, by contrast, are hardly growing. Severe overcapacity
means that prices for electronic goods are declining and even
food-price inflation has eased significantly. Last month, Suning,
China's second-biggest home-appliance chain, announced a 25%
cut in the prices of air conditioners in response to discounts
offered by Gome, the market leader, and China Paradise. Store
density is already high in urban China: Shanghai's Gubei district
has seven hypermarkets-one for 34,000 people compared with one
for 48,000 in France, where Carrefour invented the hypermarket.
Yet customers can spend little. The average spend per visit
in Shanghai is tiny, just 50-70 yuan ($6.30-8.80).
Michele
Mak, a China retailing analyst at Credit Suisse First Boston,
says these mounting pressures are already showing in the industry's
2005 financial results. Store productivity is declining, sales
per square foot are falling and profit margins are shrinking.
Operating margins at Gome, China's second-largest retailer by
sales (see chart 2), declined from 6.2% in 2004 to 4.4% last
year. Those at Lianhua Supermarket, the main grocery arm of
Bailian Group, the domestic market leader, fell from 2.4% to
1.9%.
Yet the headlong expansion continues, either through the opening
of yet more new stores or through a rash of takeovers. Hong
Kong-listed Gome recently offered HK$5.3 billion ($680m) to
buy China Paradise (also known as Shanghai Yongle), which earlier
this year swallowed Beijing Dazhong. The deal will give Gome,
which dominates Beijing and the north, a leading position in
Shanghai and on the prosperous east coast. Its national market
share in appliances will rise to more than 10%.
Gome's
move is a swift reaction to the arrival in China of America's
Best Buy, which in May bought Jiangsu Five Star Appliance, China's
fourth-biggest appliance chain. In food, Wumart, a hypermarket
operator, is taking over Beijing MerryMart. Carrefour, Wal-Mart,
Tesco and Lianhua are all said to be mulling an offer for Trust-Mart,
a Taiwanese-controlled chain.
However,
most of the growth in Chinese retailing is coming from the opening
of new outlets. Gome's head of operations, Xiangwei Weng, says
his company opens a shop every 30 hours. Lianhua aims to add
500 shops across all its formats. Wal-Mart's plans for 14 more
stores in the second half of this year seem modest by comparison.
Carrefour wants to open 40-50 more stores in Beijing alone by
2008, from its existing eight. Parkson will triple its number
of stores to almost 90 within four years.
The
reason behind the rush is partly to snap up prime locations.
But there is another motive. In China, suppliers can pay heavily
to place their goods on retailers' shelves. They also lease
space for in-store displays, help pay for promotions and give
rebates. So, each time a retailer opens a new store, it can
demand more payments. This means new shops can be profitable
in their first year. But without working harder to improve sales
at existing shops, some Chinese retailers can become highly
dependent on their suppliers to finance expansion. Last year
"other income" (mainly fees charged to suppliers)
made up 64% of gross profit at Wumart; 45% at China Paradise;
44% at Lianhua and 31% at Gome, calculates Merrill Lynch.
Distracted
by expansion, most local retailers are doing little to control
costs and boost same-store sales-vital for their long-term success.
But foreign retailers are providing a model for those who want
to learn. At Lianhua's Century Mart hypermarket in Shanghai's
wealthy Gubei district, manager Wang Yue is borrowing ideas
from Carrefour's profitable hypermarket, just 2.5km (1.6 miles)
down the road. Carrefour's gleaming store is huge and, with
30,000 different products, has a range that would be impressive
in the West. At half its size, Ms Wang's store struggles to
compete and looks empty by comparison. But things are picking
up. Ms Wang has copied Carrefour's larger shopping carts and
raised her spending per customer by a fifth. Carrefour's use
of consumer research has also persuaded her to offer shoppers
more than just low prices.
Quality, cleanliness and safety, for instance, are still rare
in a country where stories abound of fake baby milk and washed
diapers sold as new. Ms Wang employs 30 cleaners (10% of her
staff) to counter local prejudice that Chinese-owned shops are
dirtier than foreign ones. B&Q, meanwhile, tries to dispel
suspicion about the low quality of Chinese-made products by
letting customers touch everything it sells. Supermarkets cater
to the same instinct by letting customers net their own live
fish from tanks in the store.
Specialist
chains are fast cashing in on middle-class preoccupations: B&Q
and IKEA reflect China's growing level of home ownership and
a passion for interior decorating. Parkson and Hong-Kong-owned
Watson are expanding on the back of growing interest in health
and beauty.
At
the Shenzhen Sam's Club, 60% of the food is now imported, says
Duan Lixia, the deputy manager, pointing to Chilean grapes,
German chocolate and alligator meat from Australia. The store's
customers can afford to own a car so there is parking for over
2,000. That helps to raise spending per customer. Car ownership
in China is still low and most stores provide free shuttle buses,
which limits what people can carry home. Sales per square foot
at the Shenzhen store are more than double those at a typical
Wal-Mart Supercentre in China. There are just three Sam's Clubs
in China, but, excited by their success, Wal-Mart plans to open
more.
Hong
Kong-run Vanguard is experimenting with an upmarket format,
Ole. Its store in Shenzhen boasts elegant wooden floors and
exotic imported foods. Sales are rising by 40% a year. And China's
own Lianhua is upgrading 100 dowdy supermarkets in Shanghai
with great success. One in Shanghai's Xujiahui central business
district outshines even Ole. It has had a 10m yuan facelift
by Japanese designers and now features a juice bar, bakery,
wine room and hot-food stalls. Sales are up by half and the
store is packed with expatriates and hai gui (returnee Chinese).
Frogs
and turtles
Move out of China's big cities or even into the suburbs, however,
and shopping habits become more traditional as income levels
fall. At a Vanguard supermarket in an unfashionable part of
Shenzhen, manager Hu Fan tries to satisfy traditional and modern
tastes. On the ground floor people net live fish and pick through
tanks of frogs, trussed turtles and glistening chicken feet.
But next to the unwrapped meat (shoppers traditionally like
to handle meat to test its freshness), are plastic-covered pieces
with reassuring expiry dates. Shoppers can choose from 130 types
of fruit, twice the number found in a typical market.
As organized retailers move to smaller cities and further inland
to escape competition and soaring rents, they face huge variations
in taste and extreme price sensitivity. This complicates distribution
further and raises costs. Wal-Mart's buying teams arrive in
a city five months before a new store opens to research local
habits: "There are thousands of uniquenesses," says
Wal-Mart's Mr. Hatfield. People in Zhejiang like toilet paper
"as rough as sandpaper"; the top seller in Kunming
is spicy chicken feet; and Shandong natives like to buy whole
steamed pigs' faces to slice up and dip in soy sauce and vinegar.
Operating
profitably in poorer markets often means switching to smaller
stores with a narrower range. Xu Lingling, chief financial officer
at Lianhua, says that whereas big foreign players, such as Carrefour,
have taken top sites in large cities, Chinese chains may be
better suited to mid-sized towns where productivity is lower.
And these may suit a different approach-such as the franchising
of McDonald's, KFC and Tupperware, which lowers the initial
level of capital investment. Avon is going further: having finally
received permission to resume direct sales in February, the
American cosmetics group has already recruited over 114,000
sales agents.
Nor
can retailers in small cities expect the same appetite for brands
as found in more cosmopolitan Shanghai or Beijing. In general,
the Chinese are brand-conscious but not loyal. They are more
interested in value and trying new things than Westerners are.
McKinsey found Sony could charge a premium of up to 40% for
televisions in developed markets, but even a 10% mark-up in
China can put consumers off. And many Chinese are impulse buyers,
susceptible to last-minute discounts.
One
response is to shift to own label goods, which Wal-Mart is doing
aggressively. Another is to move spending from general advertising
to in-store promotions. In a typical Gome store, half the floorspace
is dedicated to special product displays. These are manned by
pushy salespeople, who are cheap to hire in China and are often
paid by the manufacturer. Vanguard's supermarket in Shenzhen
has 350 staff, and 500 other people promoting not just expensive
electronics, but also cheap items like toothpaste and shampoo.
Stores
hoping to increase loyalty are starting to promote giveaways
and improve service, but often in vain. At Vanguard, buy hair
dye and promoters will apply it free (customers browse its aisles
sporting plastered hair and towels). Many "shoppers"
happily accept freebies without spending. At the Shenzhen Wal-Mart,
the buzzword is "retailtainment". Chairs are placed
around a big television so shoppers can watch football matches
in air-conditioned comfort. People with empty baskets lounge
on benches and read. Upstairs, staff oversee a baby-crawling
race. Zhang Hui Lan, 64, visits daily for free food tastings
and to chat with staff, "who are much friendlier than in
the markets."
Yet
getting people to spend more-or anything at all-is only half
the task. Retailers must procure goods at the right price. In
distribution and logistics, China is far behind developed countries.
Strong regional tastes and lack of national scale stymie the
development of national brands and efficient supply chains.
Wal-Mart's 60 stores in China are served by 15,000 suppliers;
its 3,800 American ones need only 61,000. Then there are the
many layers of middlemen. Some foreign chains are starting to
deal directly with manufacturers. Wal-Mart has introduced its
notoriously hard-nosed negotiating tactics. At its Shenzhen
headquarters, buyers bargain in rows of cubicles strewn with
goods. Just like Wal-Mart's headquarters in Bentonville, Arkansas,
the cubicles have no doors, in order to discourage the passing
of bribes.
As
they gain scale, big chains are also opening modern distribution
centres. At the Wal-Mart centre near Shenzhen, a vast effort
is under way to link suppliers electronically to the retailer's
systems-only 30% have been plugged in so far, while the rest
still need orders to be faxed to them. Just 20 trucks can fit
in the loading bay and they can wait for more than an hour to
be unloaded, largely by hand.
Wal-Mart
will move to a new distribution hub in September. Its old one
is outclassed by the cool efficiency of Lianhua's distribution
centre in north-west Shanghai. There everything is automated
and sorted on conveyor belts using barcode scanners and sophisticated
lifts. Yuan Zhongmin, who runs the centre, says that with half
his former workforce he can shift 60,000 cartons every ten hours,
compared with 25,000 previously. The cash tied up in inventory
has fallen from 100m yuan to 27m and the rate of mistakes in
orders has fallen from 1% to 0.0016%.
Such
improvements show how rapidly China's own retailers can catch
up with the best of the foreign chains. Competition is therefore
bound to get even more intense. Some retailers' profitability
could suffer as they wait for the spending power of the emerging
middle class to increase. But there will be handsome rewards
for those that can survive this battle of hypermarket proportions.
