China – A Golden Minefield
by Steve Ivie, NAMNEWS

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Since their entry into China in the mid 1990’s, international retailers have been drawn to the booming Chinese market in increasing numbers.  Besides Wal-Mart, who pioneered the drive into China, the country now reads like a who’s who of international retail.  Carrefour, Auchan, Tesco, Metro and Ito-Yokado, to name but a few have entered this most dynamic market and are without exception rapidly expanding their operations there.

Market Growth

The saturated food retail markets of North America and Europe mean that key players such as Wal-Mart, Carrefour and Tesco are racing to increase their foothold in the Chinese market, where a fragmented food retail sector combined with outstanding market growth offers huge potential to international firms.  According to figures from IGD, China will become the world’s second largest food retail market by 2020 behind the US.  In 2003 the Chinese food market was 35% of the size of the US market; by 2020 this will figure is expected to rise to 82%.  China’s food industry sales took off in the mid 1990s rising from under 100bn yuan (€9.2bn) in 1991 to well over 400bn yuan (€37bn) just ten years later.  IGD forecasts that by 2020 the US will account for 19% of the global food retail market, a decline from 22% in 2003.  By contrast, the proportion contributed by China will nearly double during this period, from 8 to 15%.

China’s retail sales grew by 12.8% in October and 12.4% in November to 590bn yuan (€60.8bn), according to the Chinese National Bureau of Statistics.  This staggering growth, when compared to western markets, is being driven by rising salaries and the migration of hundreds of millions of rural workers to the cities  spurring demand for consumer items.  For the first-half of 2005, retail sales are estimated to have grown by 13.1%, compared to 13.7% in the first-quarter.  Retail sales are expected to grow by 13% for the first nine months and 12.8% for the full-year, according to a report by the Macroeconomic Research Institute under the National Development and Reform Commission.  This compares with growth of around 1% in the UK.

Since the mid 1990’s, foreign retail groups have invested nearly US$1bn in China, and now operate more that 4,000 outlets nationwide.  However, despite this rapid expansion, international retailers hold only a 3-4% share of the total grocery market, leaving enormous scope for growth.  The vast majority of this investment has been focused in the hypermarket and supermarket sectors, where foreign funded firms own about 40% of large supermarkets – those over 8,000 sq. ft. in many Chinese cities, according to the Minister of Commerce.

This rate of expansion has accelerated post-December 2004, when as part of its commitment to the World Trade Organisation the Chinese government lifted restrictions on international retailers, permitting them to operate without a local partner, to open as many stores as they like in any part of the country and to source from suppliers that had previously only been allowed to export.  Designed to protect domestic retailers from being swamped by international firms, the lifting of these restrictions is likely to spell the end of such joint-ventures.  International retailers now have the freedom to develop their Chinese businesses along their own, successful business models without being forced to compromise with a usually considerably smaller local partner.

Key Players

Supermarkets remain the largest and most widespread chain retail format, commanding a presence even in smaller cities in the interior but these are starting to suffer from competition from hypermarkets and convenience stores.  The supermarket sector is dominated almost exclusively by domestic chains, with Lianhua and Hualian by far the largest and the only two that can legitimately claim to be nationwide players.  In 2003, Lianhua posted turnover of US$3.2bn.  The company has been expanding rapidly and during 2005 the chain expects to add at least 600 new stores.  As of the end of June, it operated 3,377 supermarkets and convenience stores, up from 2,706 a year earlier.

Beijing-based rival Wumart Stores Inc. has said it is sticking to a strategy of expanding around the Chinese capital because home-ground dominance lets it secure better terms from suppliers.  The group is also likely to capitalise on the slower pace of growth in the capital compared to Shanghai and Guangzhou which are rapidly approaching saturation point for both hypermarkets and convenience stores, with per-store profits in decline.  The success of Wumart’s strategy can be seen in its projected results for the first-half to June 2005.  JP Morgan estimates that Wumart’s sales grew by 64% to 2bn yuan (€200m), while net profit is seen up 49%to 73m yuan (€7.5m). Nonggongshang and Suguo are also major competitors in the supermarket sector, with Nonggongshang expanding beyond its base in East China in recent years. 

By contrast, hypermarkets have tended to be limited to China’s first and second-tier cities.  In the Hypermarket sector Carrefour and Metro along with Lotus and Wal-Mart remain the strongest players in the market.  Carrefour is currently the biggest international retailer in China, but with Wal-Mart expanding aggressively during 2005, many industry experts expect that it will take the lead next year.  Last year Wal-Mart and Carrefour were neck and neck with turnovers of US$1.6bn, while Metro followed closely at US$1.3bn.  Wal-Mart is also looking at smaller cities such as Yuxi in the southern province of Yunnan, where it currently has one store in the capital Kunming.  Wal-Mart currently has 50 outlets in 23 cities including Beijing, Harbin, Shanghai and Shenzhen,   Carrefour has 65 stores in the country and recently stepped up the pace of investment in south China with openings Guangzhou and the other in Shenzhen.

Tesco’s joint-venture Hymart-Hymall has announced it is to open 15 new outlets in cities including Beijing over the coming year, from the 32 chain stores it currently operates.  The group recently staged a company board meeting in China – a move that reflects the importance that Tesco’s top management is placing on the market for future potential growth and supplies.

Metro was the first foreign retailer to take advantage of the liberalisation of China’s investment restrictions, when in May 2005 it increased its stake in its joint-venture from 60% to 90%.  The group, which currently operates 25 stores on the Chinese mainland recently announced that it plans to open an additional 40 stores over the next three to five years. 

Like hypermarkets, convenience stores have largely been limited to main urban areas and are comprehensively dominated by domestic retailers.  Nearly all of the Chinese convenience chains are subsidiaries of larger retail groups.  Quik is owned by Lianhua, Alldays is owned by Nonggongshang, Kedi is owned by Bright Dairy (in turn owned by Nonggongshang), and Lawson’s is a joint-venture with Hulian.  However, foreign firms are gradually establishing themselves.  In April 2004 Seven-Eleven Japan made in-roads into the Chinese market via a joint-venture with a local partner, and now operates 25 directly run convenience stores in Beijing.  The group has recently announced that it plans to open its first franchise stores by the end of the year, and increase this to 350 stores by 2008.  Dairy Farm also plans to increase its 7-Eleven franchise portfolio in China, but Chief Executive Ron Floto declined to specify numbers.  A further development in the convenience sector is the news that Spar

Group has been given permission to establish a wholly-owned foreign enterprise in partnership with SIMS Trading Company Ltd.  The Spar Group will hold a 50% ownership interest in the new entity, which will be headquartered in Shanghai and will be called SPAR (Shanghai) Field Marketing Company Ltd.

Cultural Hurdles

Although there has been great activity in the hypermarket, supermarket and convenience sectors, ‘Wet Markets’ continue to dominate smaller cities and retain a presence even in the most developed urban areas.  These outlets are unlikely to disappear in the short-term as they remain to be the preferred source for low-cost vegetables and meat.  But with the growing wealth and consumerism of the Chinese population, national eating habits are changing.  In urban areas particularly the population is increasingly turning to hypermarkets and supermarkets as their staple food sources, rather than traditional food vendors.  This process is likely to continue as the government seeks to drive both rural and urban consumption.  Qi Jingmei, a senior economist at the State Information Centre, said, “More spending is what the government wants to see, because it wants to increase consumption but curb over-investment,” she said.

There are several reasons for why foreign expansion has been limited primarily to China’s first-line cities located predominantly along the eastern seaboard.  Perhaps the main factor has been the gaping rural-urban divide.  The urban population accounts for 41% of the total population, and has an annual household expenditure twice that of the rural population.  Xu Ming, Deputy Director of the Ministry of Commerce market system development department, said China will develop chain supermarkets and express stores in counties and major towns, and transform country fairs to chain stores.  The government is also encouraging retailers to update rural grocery stores into distribution outlets or franchisers.  “The infrastructure of commerce in rural areas is relatively weak on the whole, which is a major factor behind the widening gap between rural and urban consumption growth” the Ministry of Commerce said.  However, in the last two years rural incomes have grown faster than urban incomes as food and grain prices have risen and the government has cut agricultural taxes.  Rural retail sales grew by 10.5% in August, which, although slower than the 13.5% growth in urban areas has justified growing investment outside China’s main urban conurbations.  Predominantly domestic retail chains are now accelerating investment in the centre and west of the country.

Another factor determining the location of investment is the under-developed supply chain.  International retailer’s supply chains remain immature, largely because of their lack of scale.  Problems abound when this is applied on a national level.  Considering the vastness of the Chinese mainland, and great variations in its topography, the inherent difficulties in supplying potentially far-flung outlets across China make the mind boggle.

Cultural differences have been cited as a potential hurdle to international firms success in China.  The example of Carrefour in Japan, where consumers failed to accept the retailer’s big box strategy is often cited.  However, in China the cultural hurdle that many felt may hinder western expansion does not appear to have materialised.  Although at present the vast majority of Chinese citizens’ consumption lies in daily consumer goods, with loyalty to local brands, China’s rapid sales growth would suggest that this can be attributed to a simple lack of market penetration on the part of hypermarket operators, rather than any great cultural reservations by the Chinese population.

However, while the Chinese Government may have liberalised the retail market it is far from giving foreign firms free reign and continues to keep tight control on expansion.  Kingfisher Chief Executive Gerry Murphy said, “China will allow substantial western participation but not dominance.  The government will use planning and environmental laws to keep a lid on foreigners and develop local companies.”  The government has also warned foreign retailers to abide by Chinese rules or face curbs to their expansion plans.  Foreign retailers that fail to rectify irregularities in a timely manner will be banned from opening new stores or co-operating with local partners.

The pitfalls of the Chinese market are well known to retailers.  China is one country, but with 32 very distinct markets, and any attempt to apply a nationwide business model is difficult.  Any retailer looking at entering the Chinese retail market must ensure the flexibility to adapt to rapidly changing consumer trends if it is to succeed.  However, the fragmented nature of the market combined with outstanding sales growth are an undeniably attractive mix.  As Joanne Denney-Finch, Chief Executive of IGD said, “The race to win has only just started and the next five years will be critical."

Steve Ivie, Assistant-Editor NAMNEWS Ltd.
sivie@namnews.com

Date article published: 13/10/2005