If the golden era for foreign investment in China is ending, the golden era of its markets has barely begun. During the 1990s, countless companies arrived in China intent on selling their products in the country’s vast consumer markets. Many were disappointed. Despite heavy investment, returns were pitifully low in many sectors. Among the many casualties were virtually every foreign brewer, various electronic consumer-goods makers, automakers, including General Motors, and a host of other companies that mistakenly thought “China's emerging middle class”— potentially tens of millions of new customers—was ready for them.
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exhibit 2-5 The three major consumer regions
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Until now, the reality of China’s consumer markets was very different from the dream. But oddly enough, just at the moment that China’s growth seems to have slowed, its consumer population is finally ready to emerge in force. The steep slope of an S curve of demand is increasingly apparent, in which rising consumer interest snowballs— not for any single product, but for the total population of accessible consumers in China.
Currently, three areas stand out as the primary places with significant consumer potential (see exhibit 2-5):
• The Yangtze River Delta region, centered on Shanghai, with a population of just more than 80 million and a GDP of around Rmb4.5 trillion, or about US$660 billion (roughly comparable to that of Turkey, Poland, or the U.S. state of Illinois).
• The Pearl River Delta, centered on the axis between Guangzhou and Shenzhen, with a population approaching 45 million and a GDP of Rmb2.5 trillion, or about US$365 billion (roughly comparable to that of Greece or Massachusetts).
• The Beijing-Tianjin region, often referred to as the Bohai Sea region, with a population of around 25 million and a GDP of around Rmb2 trillion, or about US$290 billion (roughly comparable to that of Ireland, South Africa, or Maryland).
Most foreign companies looking to sell their goods into China concentrate their efforts in these three regions, for several reasons. They account for almost half of China’s GDP and have relatively high per capita GDP, around US$5,000-6,500. 10 Although there are many other middle-income households in cities across China, in the past they have remained too dispersed to form markets that are readily reachable by most businesses, especially foreign ones.
But that will change. One key factor in pushing China’s consumer markets on a relentless growth trajectory through the next decade is urbanization, driven by the continued migration of people from rural areas to urban centers (see exhibit 2-6).
Since 2000, the urban population has grown by more than 125 million people. That’s a large figure, but it’s barely more than half of what we will see in the next decade. By 2020, another 200-million-plus people will be living in cities, making the urban population 56 percent of China’s total. These national figures don’t fully reveal the most recent upheavals. In the provinces of east China, urbanization is far higher (at 55 percent of the population) than the center of the country (40 percent) or the west (just above 35 percent).
According to the World Bank, the return on labor in services is around three times that of agriculture; in industry, it is around ten times as much. In other words, there is no better way of generating economic growth and raising per capita income than generating industrial jobs for rural inhabitants. That’s exactly what happened in
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exhibit 2-6 China's urban population, 1980-2020, millions
1980 1985 1990 1995 2000 2005 2010 2015 2020
China during the last two decades, as peasants left their fields to work in the factories of the eastern and southern coasts. And it will continue to happen in the coming years, with many new urban residents in central and eastern China. 12
The switch from being a predominantly rural to a predominantly urban population will have an impact on almost every aspect of Chinese life. A massive new wave of people will be lifted from poverty— probably far more in the next few years than in the past few decades. And after 5,000 years of being a predominantly rural, agricultural country, China will find itself a country of city dwellers virtually overnight. The overall impact of this new urban prosperity on the markets of open China will be enormous; and the enormity is made even clearer by looking at the breakdown of the country’s communities by size.
Since the start of the 1990s, the most prosperous segment of the population has been concentrated in the largest metropolitan areas of China’s coastal regions and their immediate hinterlands. Shanghai, Beijing, Guangzhou, and Shenzhen are typically identified as the “big four”: the largest cities with the highest income, largest population base, and largest GDP scale.
Following this is a group of about twenty “tier-two” cities. These are mega cities in their own right, home to between 4 and 32 million
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people each. (Chongqing is the largest, but only 6 of its 32 million residents are urban.) These include such major centers as Dongguan, Nanjing, Wuhan, Hangzhou, Shenyang, and Harbin. This group also includes four smaller cities—Zhungshow, Xiamen, Changzhou, and Zhuhai—whose lower populations are offset by their higher per capita GDP.
During the course of the 1990s and 2000s, a larger market, particularly for consumer goods made by domestic manufacturers, was added in so-called third-tier “emerging middle class” cities. These include cities like Dalian, Qingdao, Shantou, Kunming, Zibo, Huizhou, Shijiazhuang, Fuzhou, and Changsha, many of them provincial capitals, and all with between 2 and 4 million inhabitants. When people talk of China’s middle classes, they are referring to the average population of these first three tiers.
But the vast majority of the current urban population live in the next two tiers. Tier four, the “next wave,” comprises about 140 cities with populations of 1 million to 2 million. And there are more than 400 cities in tiers five and six. These are the rural and remote cities, respectively, with populations of 500,000 to 1 million. 13 The so-far elusive market of hundreds of millions of Chinese consumers will be found in tiers four through six (see exhibit 2-7).
exhibit 2-7 Socioeconomic levels of city tiers
GDP Per Capita
$ 12,000 - 10,000 8,000 - 6,000 4,000 - 2,000 0
Width of bars represents population
Source: China Statistical Yearbook, Literature Research, Booz & Company Analysis
TIER 1: Big Four
TIER 2: Mega cities
-TIER 3: Emerging middle class
—TIER 4: The next wave
TIER 5-6: Rural and remote
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Most of these cities can be expected to grow, especially those outside the Yangtze River Delta, Pearl River Delta, and Beijing-Tianjin regions. As these cities grow in clusters, they will evolve into new regions of relative wealth and prominence. To spread growth more evenly around the country, the government is encouraging the creation of a series of new city clusters. They are located in the northeast, around southern and central Liaoning province; around Qingdao and the other cities of the Shandong Peninsula on the north China coast; on the southern Fujian coast, opposite Taiwan; in the middle reaches of the Yangtze, around Wuhan; around Chongqing, on the upper reaches of the Yangtze, and its neighbor, Chengdu, the capital of Sichuan, and in central Shaanxi province, around Xian.
Jinjiang, in the southern part of the Fujian province, is a good example of this extraordinary growth. Its population of 1.02 million people places it solidly in tier three. It is home to many thriving Chinese manufacturers and branded companies, including sports shoe and apparel makers such as Anta and X-Step; apparel companies such as 361 Degrees, Jiumuwang, and Septwolves; and Hengan, China’s leading paper products company and a key competitor to Kimberly-Clark and Procter 8c Gamble.
Expressways linking many of these new city clusters are already in place; expanded rail links should follow in the next ten to twenty years. Almost all of these regions have some form of industrial advantage already, and have attracted significant levels of foreign investment, if not at the same volume as along the coast. Some multinational companies are expanding into these markets, with much depending on the type and degree of distribution and support they need. These companies include Coca-Cola, which markets its products in every part of China; KFC, with restaurants in more than 450 cities, including most of the tier-three cities; and Procter 8c Gamble, which has built China’s most developed distribution network for fast-moving consumer goods.
For most multinationals, therefore, a crucial question is where and at what rate other concentrations are being formed beyond the “big
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three” regions, and when these new markets will become sizable enough to merit attention.
The ability to anticipate and reach consumers in tiers three and four (and more rural areas) will determine how successful a company can be in China over the next decade. Just since 2008, driven by increasing government incentives and residential income growth, demand is growing in these areas for consumer electronics, entertainment, and travel—with car and house purchases on the agenda for many families in the next several years. A sharply honed sense of timing will be just as important: go too early and a lot of money will be wasted; enter too late and competitors will have already established themselves.
If China’s urban population, especially in its third- and fourth-tier cities, is set to expand dramatically in the next decade, how will companies reach those markets? The government has begun to address this question, identifying distribution as a key area for improvement. Over the past fifteen years, it has made massive investments in transportation infrastructure, especially roads.
At the start of the 1990s, China had just under 200 miles of expressways. It now has over 40,000 miles. Almost all of its major cities have new or totally rebuilt airports. And investment in its railway system, after lagging badly for most of the last two decades, is being rectified— after just adding some 12,000 miles of track between 1990 and 2008, another 7,500 miles will be laid by the end of 2010 (see exhibit 2-8).
China has also liberalized its distribution sector to a large degree. It has opened road transport and other logistics industries to foreign companies, and it has started to encourage the consolidation of numerous, small domestic transport companies into a few integrated giants with nationwide reach and corresponding economies of scale. Admittedly, progress on the latter front has been slow. Trucking companies in
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particular have proliferated as the expressway network has grown. And at both a central and local level there remains a tendency to focus on developing “hard” infrastructure, such as highways and logistics parks, rather than the equally important forms of “soft” infrastructure: communications, software (for managing logistics, for example), and managerial capabilities.
The current expressway network’s greatest shortcoming is that it largely connects only cities with populations of half a million or more. Most third- and fourth-tier cities are reachable only by standard highways. But this too will change, with the 7-9-18 scheme—the most ambitious road-building project in world history—comprising seven expressways starting in Beijing, nine north-south routes, and eighteen east-west routes. With a total investment of $250 billion, its 53,000 miles will link all of China’s cites with a population of 200,000 or more by the time it is completed in the 2030s.
Meanwhile, the country is at the start of a retail revolution. Currently, the vast majority of shopping outlets remain the market stalls, corner shops, and kiosks used by most Chinese citizens to buy everyday necessities. But this is changing. The change began in 2001, when China joined the World Trade Organization and foreign retailers and wholesalers were granted permission to operate anywhere in China. There has since been an explosion in shopping options, with both do-
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OPEN CHINA
mestic and foreign retailers involved. Supermarkets, twenty-four-hour convenience stores, and chains of all sizes are spreading within larger cities, led by international companies such as Carrefour (with about 140 individual stores), Wal-Mart (with about 150 stores), and a few Chinese retailers such as the electronic goods seller GOME (with more than 1,300 outlets) and Suning (with more than 800 stores).
The rapid growth of retail chains, and their correspondingly more sophisticated formats, have compelled distributors to meet their customers’ new needs. This represents a major improvement in the rapid movement of consumer goods and food, especially if the distributors can deliver direct to the stores themselves, or to the retail chains’ distribution centers. That improvement is still relatively weak; it is held back by the highly fragmented and inefficient nature of China’s retail, transport, and logistics industries. In Europe and America, logistics costs are the equivalent of less than 10 percent of GDP; in China, the figure is roughly double that.
Given the amount of time and money that it takes to build a distribution network, many companies have opted to outsource theirs. This will make sense as long as China’s transport and logistics sectors remain fragmented, and until these sectors gain experience in managing modern logistics systems. But that day will come and, as often happens in China, it may transform with dizzying speed.
One company widely acknowledged to have well-developed retail distribution structures and processes is Procter 8c Gamble (P&G). It entered China in the 1980s and first developed a distribution network for shampoo. Then, P&G added other products one by one, building on its experience both in reaching markets across the country and running marketing campaigns to support the launch of each new category of goods.
Another success story is KFC, the most successful restaurant chain in China—foreign or domestic. This is, of course, the same chain as the American KFC, with a signature dish of fried chicken. Since arriving in 1987, it has set up more than 2,900 restaurants in 450 cities, with
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around 300 new outlets opening each year. McDonald’s, its biggest rival, has less than half that total, and is only adding new locations at less than half KFC’s rate. With a turnover of around $2 billion, China is KFC’s second-largest market after the United States, and its largest source of earnings growth. KFC’s parent, Yum! Brands, does not publicly reveal the chain’s profitability. But Sam Su, the company leader who oversaw KFC’s successes through its two-decade presence in China, and who now heads up Yuml’s operations in the country, pointed out recently that the top brand in a sector typically enjoys the best margins, that KFC is clearly the fast-food leader in China, and that he is “very happy” with the amount of money KFC is making. 15
There are several factors behind KFC’s success in China. First, it has managed to build a strong supply chain. Although the decision to do this may have been easy to make, implementing it was another matter. Like Procter & Gamble, KFC spent a long time—-nearly a decade—figuring out its basic model, which gave it the foundations it needed to embark on its rapid restaurant rollout in its second decade in China.
Another critical factor was the decision to appoint Sam Su to head up its China operations in the first place. Su quickly surrounded himself with a new senior team. Like Su himself, most of them had been raised in Taiwan, had experience doing business in international settings, and understood the nuances of working in a Chinese business environment. With this team in place, KFC set out to develop a business that was sensitive to the customs and habits of Chinese consumers. This is of vital importance when dealing with such a culturally sensitive product as food. It was only possible because Su and his team operated with a deep, ingrained awareness of the nuances of the China market and work environment.
Putting in place a team that understands China’s complexities is of vital importance. That doesn’t mean that all team members have to be Chinese. Indeed, companies can create problems by putting someone in place simply because she or he has a certain ethnic background. But it does mean that companies should think long and hard before
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staffing a key post with someone with a strong business background but little China experience. It also suggests that rotating people in and out of the country may be the wrong approach to talent management: in-country experience is extremely valuable and worth keeping focused on China.
A related third factor was the fit with China: KFC deliberately adopted products and practices that would mesh well with the inherent qualities of the Chinese markets it was trying to reach. Far too many companies start with the false perception of China as an undeveloped but fast-growing market; they conclude that products and systems that have proved successful elsewhere should have a high chance of succeeding in China. That premise puts their thinking into a box from which it can be hard to escape.
Fourth, KFC put all of its employees’ knowledge to work. Su’s team chose the right people to take care of its business, and then let them do things as they saw best in the light of local conditions. They avoided bringing in practices from elsewhere until they had been tested and found to work. Inside the restaurants, they trained staff: one manager who worked for Su says it takes five years for a local manager to develop an in-depth understanding of how to manage a Western-style fast-food restaurant. Outside, they worked with suppliers and built out a dedicated, in-house logistics and distribution network—city by city, region by region.
A final factor was patience. The members of Su’s senior team took their time. They began by looking at the whole range of the company’s operations, from its menu offerings to its supply chain. Their first conclusion: that food, not systems, was the most important thing to get right. They gradually extended the menu, experimenting with different items, often making them available for just a limited period. They invested in ovens so they could offer more than fried food, and began selling juices, salads, and congee, a Chinese version of porridge made from rice. They allowed the extra time they felt was necessary for their strategy, rather than rushing ahead with ambitious expansion plans and hoping for the best.
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KFC took nearly a decade to open its first one hundred restaurants. But its patience paid off, with exponentially greater growth in the chain’s second decade, and with it the revenues and profits that companies dream of when they think of China.
Companies will always be under enormous pressure to have ambitious short-term growth targets. But the experience of successful and durable companies in China—including IBM and Nokia as well as P&G and KFC—suggests it is better to build slowly and fit practices to China’s conditions than to try to work on too many fronts at once, especially if expediency would lead to adopting practices transplanted from outside without carefully assessing their merit. Companies with a longer-range perspective and a solid foundation in China will be much better prospects for both employees and investors.
As I noted at the start of this chapter, Chinese consumers can choose from an enormous variety of brands and products, possibly more than in any other market worldwide. But while large consumer markets can be found in China’s glittering new cities, it would be a mistake to treat them as single homogenized markets. Although China’s markets are global in nature, they are also extraordinarily local, rooted in traditional customs and tastes, with extreme variations from one region to the next. In a country with the area and population of China, this should not be surprising.
Even along the coast, the differences among regions is enormous. Shanghai, Zhejiang, Fujian, and Guangdong each have their own spoken dialects (in Guangdong’s case, more than one). The Mandarin language unites the northern half of China, but only barely, with major differences in dialects among provinces, and sometimes among neighboring cities. People from Beijing and Shanghai can be easily identified by their speech. Regional tastes remain as strong as ever, especially when it comes to food.
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Even in the wealthiest provinces, such as Guangdong, just to the north of Hong Kong, or Zhejiang, to the south of Shanghai, you need only travel a short distance inland and incomes fall abruptly. The rural- urban divide is one that splits the nation, but it is only one of many divides. There is the east coast and the rest of China, especially the far west. Another divide exists between the dry north and the wet south— a disparity that is likely to grow if global warming proceeds as expected later in this century. There is another gap between the densely populated east and center of the country, and the sparse west and northwest. Within cities, there is a divide between permanent residents and migrant workers lured from inland provinces.
The combination of fast but differing rates of growth, population movement, and continual economic and business restructuring, all taking place across a continent-sized country, means that China and its markets are both diverse and complicated in multiple dimensions. Although development is making China more homogeneous in some ways—electricity, television, and roads penetrate even the most remote areas—in others it is becoming less so. Mass media, the Internet, and overseas channels are opening up segments of the population to influences from outside the country. Young people are forming their own interests, distinct from those of their parents and older generations.
With all this come big differences in levels of exposure to and knowledge of products and services—and major variations among the markets that companies are trying to capture. The speed with which China has developed has disrupted traditional patterns of consumer development that build brand loyalty over time. In China, instead of products arriving in a predetermined order, from essentials to luxuries, from low end to high, everything has arrived almost simultaneously. People who were living in frugal, company-assigned and -owned apartments a decade ago now have their own homes, a huge array of consumer durables, access to a raft of brands for every daily purchase, and (in many cases) cars. With little or no history of consumption, these consumers are hard to reach with conventional marketing techniques developed elsewhere. Thus the
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masses of Chinese people tend to be difficult for marketers to reach: fickle, willing to change brands rapidly, often shopping on price alone. And yet there is a rapidly growing group of people at the high end, who are very brand conscious, with the ultimate goal of showing off their wealth as they acquire known brand products. With markets and tastes continuing to change rapidly, it is difficult to predict what kind of evolutionary path China’s consumers will follow.
Will the evolution of the Chinese market continue to be different from elsewhere? Over time consumer habits and tastes may converge with those in other markets, but perhaps only to a degree, and it will take some time. For the next decade, many differences and variations will distinguish the Chinese market from the rest of the world. China remains open to entry, but before they enter, most companies should focus on developing an awareness of Chinese cultural ways and patterns, and how these are changing under the nation’s new openness. In addition, any company intent on penetrating China’s markets will have to take a clear look at its competitors. Just as China’s openness has allowed foreign companies to enter the market, it has also bred one of the fiercest competitive environments in the world, the topic of the next chapter.
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CHAPTER 3