GLG News by Paul French

Implications:  

Inflation worries have translated into consumer worries in China

But they need not worry in terms of non-food sales

And it is an urban issue not a rural one where most people live

Analysis:

Most people have a knee-jerk reaction to the word “inflation” – that it is bad. This is especially so when the idea of food price rises are brought up – leading to visions of panic food buying, long queues and empty shelves at the supermarket and the threat of rationing. In some ways, there was perhaps an element of this kind of reaction to the recently released Consumer Price Index (CPI) figures for February this year. Concerns about inflation in China rose following the announcement of the February figure on the 13^th of March. The 2.7% increase in the CPI was seen by some as uncomfortably close to 3%.

However, what this overall CPI number masked was that most (about two-thirds) of the growth in overall price inflation was coming the rise in food prices. In fact, the non-food portion of the CPI represented only a rise of 1%, the other 1.7% coming from food. Rather than panic about this, it is worth putting this into some historical perspective. The most crucial of these is that food prices have remained largely flat for almost a decade, and have only recently begun to rise. They are in fact catching up with growth in the consumer economy and consumer demand.

Most consumer demand in China comes from the cities – where little food is produced. Food has remained relatively very cheap for the average urban Chinese, and what this sharp growth in prices (edible oils up 17%, poultry up 15%, eggs 30%, fruit 8% and grain by 7%) is in reality more of a correction in prices in relation to demand, and the cost of production and delivery. The rise in food prices will actually help the economy, rather than create any slowing in the consumer economy. Higher food prices will put more money into the pockets of the poor rural farmers, 150 million of whole live on less than US$1 per day. If they can earn a more reasonable living from the crops they grow, so their chance of raising themselves above the poverty line, and becoming future potential consumers increases.

Implications:  

So far cases of discrimination over HBV have been mainly made against Chinese companies

The Beijing government last year decided to outlaw anti HBV carrier discrimination

The Nokia case indicates a lack of control by the Chinese entity over its subsidiary factories

Analysis:

A 24-year-old Chinese job applicant recently filed a lawsuit against Nokia in China alleging that a local unit of the telecoms giant refused him employment because he is a carrier of the Hepatitis-B virus (HBV). We’ve reported before on discrimination against HBV carriers in China and despite the government banning discrimination for government posts Chinese companies routinely refuse to employ people who carry HBV, even though it is mainly transmitted at birth, through sexual contact or by contaminated needles. The Chinese Ministry of Health estimates that over 130mn Chinese are HBV carriers with a further 30mn diagnosed as HBV patients, meaning the virus has affected liver function. Open discrimination against HBV carriers appears to be most prevalent in the manufacturing powerhouse of Guangdong province in southern China.

This case is one of the first in China involving a foreign company accused of discriminating against a HBV carrier. The unnamed Henan graduate filed a lawsuit in March against Nokia’s subsidiary in Dongguan, Guangdong, accusing the company of rescinding a job offer after discovering he was HBV positive. This latest lawsuit follows others including one last January by a Hubei man who sued Hong Kong technology company VTech Holdings in Dongguan after he claimed he was rejected for a vacancy due to being a HBV carrier.

The situation is so severe that many workers feel that contracting hep-B is the end of their working life – the press and public were shocked when a man hanged himself in Zhongshan, again in Guangdong, just days after he was rejected by a factory run by giant Chinese appliance maker Galanz because he had hep-B. The Southern Metropolis News, a Guangzhou-based paper reported that despite passing all the employment tests he was denied employment due to hep-B. He reportedly told a friend before his death that he would be ashamed to go home without having earned any money. In response Galanz’s HR department has admitted that it rejected the man because he was found to be a dasanyang patient, meaning that the hepatitis virus was in active reproduction. Galanz, like many Chinese companies in Guangdong, has a policy of turning away dasanyang patients believing the disease could spread to others. However, research has shown that HBV cannot be spread through casual contact such as chatting, sharing a workstation or bathroom.

Following the Nokia lawsuit, and a report in the Guangzhou-based Yangcheng Evening News that Nokia had admitted it would not recruit people with HBV, support groups have swung into action. The Guangdong Association for the Study of Liver Diseases has launched a free service offering written testimonials to HBV carriers allowing them to prove they carry no risk to others. Additionally the man suing Nokia is expected to bring Nokia China to court as the second defendant in the case as well as the individual subsidiary. He is supported in his court action by Yirenping, a Chinese support group working to end discrimination against HBV and AIDS carriers. In its defence a Nokia China spokesman told the Yangcheng Evening News that Nokia would never discriminate against HBV carriers and has employees diagnosed with HBV at the factory. “We are investigating the Dongguan case and will rectify it if some of our staff have made mistakes,” the company said.

Implications:  

China’s Communist leaders want to see more of the wealth generated by both public and private enterprise being invested into charitable and social “good deeds”,

92.5% of Chinese firms made donations in cash last year – this is now set to increase

Although it remains to be seen how much of a direct effect the new tax breaks to corporate philanthropy will have.

Analysis:

The annual session of the National People’s Congress (NPC), which is China’s premier policy-making forum, has recently concluded with a raft of new policy aimed at promoting better investment in the corporate sector, particularly with the fast-growing private sector in mind. Much of the latest corporate tax adjustment has been aimed at equalising the tax burden between domestic and foreign companies, in line with China’s WTO entry commitments, so that both will pay an equal rate of 25% (where foreign companies used to get a preferential 15%). These commitments meant that China had to fully comply to international WTO guidelines by the end of 2006.

One of the revisions to have come out of the latest round of policy-making, is a change to the proportion of company charity donations, against their annual profits, that are now exempt from tax. This proportion has now risen from the original 10% to 12%. This represents a clear message from the government. China’s Communist leaders want to see more of the wealth generated by both public and private enterprise being invested into charitable and social “good deeds”, and is encouraging a greater scale of corporate philanthropy and responsibility. It is also interesting to note that as well as tax exemptions on donations, there are also new tax incentives for companies investing in water-saving and energy-saving projects.

So what was the level of corporate donation before now? Well, in April 2006, the Hurun Report, which describes itself as a “luxury business portal” released a list of the top-50 corporate philanthropists, which was published by Rupert Hoogewerf. The report sees donations ranging from just under US$2,000, right up to US$250,000. Most of the donations were made towards improvements in education, into social welfare establishments and poverty relief. All of the donations on the List were made by wealthy business leaders, but philanthropy is not the preserve of the rich in China. The China National Aviation Holding Travel Service, for instance, recently held a birthday party for eight employees in which staff members donated to the China Primary Health Care Foundation.

As far back as 2000, when a survey was conducted by the Shanghai Academy of Social Sciences’ Sociology Institute, some interesting data on corporate giving was emerging. Questionnaires on donation were distributed to 950 companies, of all ownership types. Of the 503 respondents, 92.5% had made donations in cash, goods or services within the last year, suggesting that most companies in Shanghai have engaged in corporate philanthropy, even if the non-responders had made no donations. 53% of respondents had made contributions under RMB50,000, 36% between RMB50,000 and RMB300,000, 7% RMB300,000 to RMB1m, and 4% over RMB1m. 57% of the donors had stated that their contributions went towards “poverty alleviation”, 32% to “social welfare” and 23% to “education”. Slightly more than 40% had given for disaster relief.

But this survey covered just Shanghai, and there is still no broad corporate donations culture in China. And, from the point of view of charities and NGOs in the country, the nation’s corporations are an as yet largely untapped resource. This is not due any particular lack of institutional collective charity – indeed, such activities have long been promoted by the Chinese government. Witness the nation’s Tree Planting Day, where people and companies donate trees to be planted to help reforests lost areas of woodland, as well as provide trees to aid halting the spread of deserts.

Perhaps what is most significant about the new tax incentive for businesses to donate, is that this provides a monetary incentive for companies to be more charitable, and one with a much more immediate cost benefit. As more companies in China begin to take advantage of such tax incentives, they will also begin to sense the other additional benefits of such giving, that are perhaps not so immediately apparent. Indeed, public opinion of companies in China does not rest upon brand image alone. There is growing awareness, among Chinese consumers, as to which companies are more actively involved in aiding charity and good causes. The benefit to companies in this, is that consumer perception of philanthropy often converts into increased consumer loyalty to that company, and hence, better sales.

In the commercial environment in China at present, where competition in most sectors is fierce, and margins tight, it begins to make economic sense to give away money to charity. The long-term feedback from such positive contributions to society in general often outweighs the cost of giving, and as more companies latch onto this idea, then more will follow suit. The problem at the moment is that very few Chinese companies are yet aware that they can afford to make such contributions, or that there is a real benefit to doing so.

It may be that foreign companies in China have been showing the way in this respect. Now, with their tax burden about to rise from 15% to 25%, there is even more of an incentive for foreign companies to “lose” some of their profit margin in charitable donation. Not only will this reduce their increased tax bill, but many foreign corporations are aware of the feel-good response from the public, following such charitable activity, and how that can translate into improved PR in the broader sense. Companies used to fighting a rear-guard action to preserve their company image, such as McDonald’s and Nestlé, are already actively involved in charitable investment in China. This may well be a means, with some selfish motive behind it, to preserve their corporate image from a constant barrage of ill-feeling. However, it does help to generate a culture of corporate giving where little existed before.

Not only can foreign companies lead by example, but they can also lead by cooperation. Many foreign companies have entered the Chinese market via the joint venture route. They therefore have an influence on how their JV partners act, and any subsidiary companies, suppliers and buyers.

It remains to be seen how much of a direct effect the new tax breaks to corporate philanthropy will have. What seems most likely, is that emerging trend for corporate giving among Chinese companies is most likely to grow much more rapidly in the coming years. Also, along with increased Chinese corporate investment in markets outside China, particularly in the nations of Africa, money directed at charities and NGOs by Chinese companies could also become increasingly significant outside the boundaries of the People’s Republic.

Implications:  

An average of about 18% to 19% of consumer incomes in China are placed into savings accounts, making Chinese savings rates among the highest in the world;

The significance of this is that there is a considerable amount of average salaries in China that is not being spent at retail outlets;

This also means that purchase of education and healthcare services has a discretionary element.

Analysis:

An average of about 18% to 19% of consumer incomes in China are placed into savings accounts, making Chinese savings rates among the highest in the world. What is interesting, is that rates of savings do not seem to decrease the wealthier Chinese become. Even in the richer cities, savings rates remain high. Considering that savings tend to be used for deposits on buying homes, education and healthcare fees, it seems safe to assume that this merely reflects the higher prices of these items in the main cities, and also perhaps the higher aspirations for better housing, education and healthcare service levels.

The significance of this is that there is a considerable amount of average salaries in China that is not being spent at retail outlets. However, were taxation of income to be higher in China, in order to provide more central and provincial government education and healthcare services (for example), then what is used in savings for such services would be taken in tax. This indicates that the high rates of savings among Chinese wage-earners are in fact a form of virtual self-taxation, providing funds for services not provided for by government.

This situation also means that purchase of education and healthcare services has a discretionary element. Even state-sector schools and hospitals charge fee rates according to the expertise and level of service quality that they have a reputation for providing, and people can choose which service they use, according to what they can afford. Thus, hospitals and schools can market themselves based on their service quality, as in the private sector elsewhere, becoming virtual discretionary retail services.

The question for the Chinese government, now committed to raising spending on public healthcare, is how best to raise the revenue needed to pay for this, and how this will effect the tax burden, and spending habits, of urban consumers.

 

Implications: Yue Yuen is showing how a Chinese manufacturer can become a brand and a retailer;

Domestic brands are closing the gap on the brand giants such as Nike and Adidas in China;

There is still a lot of possible potential for increased sales in China for all footwear brands.

Analysis:

Yue Yuen’s retail expansion is interesting as it shows that generally Chinese manufacturers are starting to understand that they can leverage their design and manufacturing expertise into branding and retailing. It is also interesting in the hyper competitive Chinese sports shoe sector where the big brands such as Nike, Adidas and Reebok are doing well but local brands are also improving their sales in terms of volumes and market share – notably domestic sports brand Li Ning. Additionally interesting is the fact that brands like Li Ning are increasingly edging their prices up while still competing closely with the likes of Nike and Adidas.

Yue Yuen will profit from both ends of the spectrum – selling more shoes for foreign brands through outlets such as its Reebok stores but also selling them and their own designs through their own YY Sports outlets.

Shoes and footwear is one of the last sectors of China’s retail market to become organized and dominated by chain retailers – at the moment the vast majority of shoes are sold through independents and small scale retailers. This is changing and Yue Yuen is perhaps the most graphic example of that in sports footwear.

China is becoming a better-shod nation but hasn’t quite reached US level yet. Americans still buy far more pairs of shoes annually.

• Chinese annual per capita shoe purchases - 1.6 pairs;
• Japanese annual per capita shoe purchases - 3.1 pairs
• USA annual per capita shoe purchases - 7.4.

Shoes sales in China are growing. Sales are expected to be up 57% in 2010 over 2005 – but that’s still just 2.2 pairs of shoes per capita.

Implications:  

Off-season price slashing has begun and has been started by GM rather than one of the local manufacturers;

This raises questions on what manufacturers are doing to slash production costs and maintain margins;

At the same time the scramble at the high end continues.

Analysis:

It’s fair to say that the auto price wars in China never went away, but this is off-season price slashing, which is less common, and it’s the foreign car makers scrabbling for share. Shanghai GM just slashed prices on its Buick Excelle by up to 7% – that’s discounts of up to US$1,000 on some models, which were priced between RMB118,000 and RMB157,000. The old problems remain, prompting the price cuts. For instance, although the new Excelle models are forthcoming, in China if you don’t shift the inventory before the new models arrive in the showroom, you’ll never shift them – they’re scrap steel basically.

Also, Shanghai GM is launching a new version of the Epica, with some heavy marketing. The Epica overlaps in the market with the Excelle, so some price differentiation is required. Crucially though the Excelle, along with VW’s Jetta, holds an important place in the mid-sized car market, so slashing prices on the Excelle could launch an all-out price war across the sector. At the same time of course, the local manufacturers can go deeper on discounts than the foreigners, who all require troublesome little things like profit margins.

Of course, all this benefits the consumer, who gets the same car at the end of the day, and keeps a grand in his or her pocket. Well almost… Price slashing obviously also slashes manufacturers’ margins, and they have to make that back somehow. Hence the following statistic: defects were found in 77% of domestically-made cars during the first six months of use, according to the latest China Automobile Customer Satisfaction Index survey. Price slashing has obviously caused domestic manufacturers to purchase cheaper parts, concluded the research. So your car is cheaper, but at best will break down more, and at worst will kill you.

Meanwhile the foreigners are still concentrating on the higher end of the market where there is less local price competition and better margins. Shanghai GM is hoping to quadruple sales of its Cadillac luxury sedan to 12,000 units in China this year - Last year the company sold 3,000 Cadillacs in China while sales of luxury cars by other makers far outstrip those of Shanghai GM's Cadillac. In 2006, BMW sold 22,550 units, while Audi sold 80,808 units.

Implications:  

Fashion retailer C&A is coming to China but may find the going tough;

The truth is that Zara’s success indicates the middle mass market is opening up but only to the right retailers;

The driving force of the middle mass market now in China’s cities is a repeat of what was seen in Japan and Korea earlier, a burgeoning Office Lady (OL) market.

Analysis:

Following the success of Spanish fashion giant Zara and to a lesser extent Mango in China there is a feeling abroad that any mid-market fashion retailer can now succeed in China. What’s interesting though is that Zara’s success is premised on a ‘double whammy’ of an excellent collection combined with good timing. The collection is ideal for China’s growing number of urban (basically Shanghai and Beijing) Office Ladies (OLs) being generally slimmer than most foreign collections and concentrating on good basics in black and white. At the same time the mid-market has started to appear in those cities where before it was mostly owned by independents and tailors – you could do OK as a high end luxury brand or a cheap-and-cheerful low cost brand but the middle was tough – just ask Benetton who found it hard going.

So now we have a couple of cities with enough OLs to support good fashion brands – Zara is selling well at the range of between RMB300-700 (the tough zone in terms of pricing) and is also doing very well with its cheaper ‘fast fashion’ items in the RMB100-300 range. The losers so far appear to be the likes of Giodano and Baleno who are seeing their clientele in Shanghai and Beijing migrate upwards and away from them to Zara.

But all of this may not be a recipe for success for C&A who are launching in Shanghai this Spring or H&M, launching imminently. They will probably get a good initial sales spike (most people do due to consumer curiosity) but may find it tough to maintain sales. H&M stands the better chance of the two – more suited to the Chinese market in terms of style and sizing. Zara has been extremely well placed to get both OL interest for its designs and prices. This doesn’t mean that a broad-based mid-market has appeared that will allow all retailers to succeed and our money would be on C&A finding life tough.

Still, the more interesting determinants of when an Asian consumer market is maturing and becoming more sophisticated is when OLs start to appear in force. Japan got them, then Korea and now its China's turn. Office Ladies (OLs) are hitting the streets of China’s cities with money in their pocket and looking for a lifestyle. The new found success of fashion brands such as Zara, Mango and others in the upper mass market women’s sector in China is a sign that women are trading up to more expensive work wear while also seeking better quality and convenience. Affordable style and smartness are the new urban woman's watchwords.

It is true that women have always formed an active part of China’s white-collar workforce but they have traditionally been lower paid than men, and been unable to break through China’s version of the glass ceiling. In part two things have changed this – firstly, in the rapidly reforming economy women have been able to emerge as entrepreneurs running their own businesses, and as well as being the boss, have been more willing to promote other women to higher management positions. Secondly, the dramatic rise in the number of foreign companies establishing offices in cities such as Beijing and Shanghai has significantly boosted the number of well paying white-collar jobs for younger women in China. The foreign representative offices are the true home of the Chinese OL.

We could be seeing a repeat of early times in Japan and Korea. Japan’s OLs were a marketer’s dream when they first appeared: mass consumers of luxury goods, cosmetics, perfumes and all the media that surrounds the fashion and beauty industries. They were a major target of the Hawaiian, Australian and European tourist boards in the 1980s. Women in Japan had excess cash for the first time and they spent wildly. They became highly body image and hygiene conscious and spent increasing amounts of time enjoying their own company. Many rejected the traditional route of marriage altogether, or at least postponed the experience. They were a familiar site across Asia on package holidays and shopping sprees. Then in Korea women still opted for marriage but increasingly delayed it in order to enjoy themselves among their own sex for a while. In South Korea the phenomenon of the Single Office Lady (SOL) became a backbone of the domestic travel industry. SOLs traveled in female-only groups, often as far as to Europe and on more local weekend activity breaks. Typically they were single women in their mid-twenties with good white-collar jobs. They became a major growth sector in the country’s travel industry.

There are several things about OLs that appeal:

• They earn decent money – good news for the retailers, skin care brands and the direct sellers like Avon, Amway, etc;
• They like to get together socially – which is good news for restaurants, bars and clubs;
• They like to shop – good news for those building good ‘destination location’ malls;
• They are open minded – good news for travel agents, airlines and hotels;
• They adopt new products – good news for anyone launching anything interesting from coffee-in-a-can to microwavable convenience foods;
• They are media savvy – good news for advertisers;
• They are often debt free – OLs earn good money and have supportive parents usually – a remarkable number of them, still in their 20s, have already paid of their mortgages and bought a car – they have higher disposable income than most.

Implications:

After three years of looking at the market Home Depot are finally planning to open in China;

The focus will increasingly be on soft furnishings in China as property transactions slow

Key to success will be the right product offering in the locations they choose to open in

Analysis:

Home Depot has been smart not to rush into China’s home furnishings and improvements market – it’s a tough one. While the press tends to concentrate on the fortunes or otherwise of the foreign chains such as IKEA and B&Q it is the locals that have made life difficult for foreign entrants. The multitude of domestic home improvement and furnishings warehouses, their cheap, cheap prices and invariably better locations have meant that life has been tough for the foreigners – IKEA has struggled with crowds in their stores but a lack of queues at their tills while B&Q has expanded faster but still only derives a dribble in income from Mainland China.

As the major property markets such as Shanghai slow and transaction levels fall so the emphasis is increasingly on soft furnishings rather than the hard stuff of plumbing, flooring and electricals. In this Home Depot’s product offering in China may now be well timed. Certainly they’ve sat around examining the market for long enough – three years now.

What will be interesting to see is whether or not the Home Depot product offering suits Chinese consumers. B&Q is working with GOD, a furnishing design company with a strong reputation in Hong Kong while IKEA carries on with its global offering.

Chinese homeowners are turning out to be more like the Italians than the Brits – that is to say they are redecorating every two or three years on average, like the Italians, as opposed to once every ten or twelve, like the Brits. Of course they can afford to do this with labour costs so low in China meaning that the installation and decoration costs are small and with low prices on furnishings and appliances the cost of a total makeover is relatively low.

The trick for Home Depot now as they open in multiple cities will be 1) the old conundrum of location, location, location and 2) judging the state of the local property market and the demands of consumers correctly. Let’s hope they’ve used that three years or sitting around in China wisely to choose a good partner and get a good understanding of the vagaries of the local market.

Implications:

Margins remain tight in China's drinks market despite rising sales.

Competition & costs continue to take their toll on profits.

The continued shake-up in the drinks industry in China is driven increasingly by these tight margins.

 

Analysis:

There seems to be a continued shake-up in the drinks industry in China, driven by increasingly tight margins. There has also been a continued decline in the number of companies in the soft drinks industry. The reason for this is that competition in the market is increasing each year for diminishing amounts of growth in the market. There have been increased operating costs for manufacturers, both in terms of raw materials, and also in distribution costs and the need for "slotting fees" to retailers to get their products placed at prominent positions in stores – with such slotting fees becoming increasingly important to retailers that are otherwise not making any profit from sales of goods.

Margins are being squeezed therefore, and this means that only the larger companies, with the economies of scale, and the established distribution networks, are making any significant money in the beverage market. Outside of these leading contenders, most medium- and small-scale manufacturers are struggling. This is forcing them to cut costs wherever they can, including down-sizing their staff numbers.

Among the leading companies, the average gross margin is probably in the region of between 10%-11%, but these margins have probably peaked. The problem is that most of the developed cities in China are already saturated with product, and that sales are not really growing significantly. One only has to look at how the convenience stores in the main cities are struggling to compete with each other in overcrowded markets, leading to low average footfall per store, and low value average basket sizes, to see why competition is so tight.

With a squeeze on margins, economy of scale becomes increasingly important, especially in attaining strong distribution and retail store placement. Marketing spending is rising in order to raise the shares of the leading brands. Again, the smaller manufacturers are losing out to those with bigger budgets.

Those bigger budgets are directed a lot more on developing new packaging types, especially to serve the catering sector, providing special vending packs and the like, which gains them favour with catering outlets. This is often part of the "closed marketing deals" between the leading soft drinks makers and the leading fast-food chains. It is these relationships that give the likes of Coca-Cola and PepsiCo their competitive edge against their smaller rivals – they are simply in more stores and "restaurants", and are therefore more visible.

However, there is a rising concern in the public and in government about the effects of "junk food" and fat/sugar-laced fast-food and soft drinks, leading to childhood and adult obesity, which is giving rise to increased numbers of people with type-2 diabetes. This could itself create problems for the soft drinks makers over the coming years. In response, you are likely to see more of the cola giants producing more sugar-free and "healthy" drinks, in order to deflect mounting consumer and official concerns about their products.

This trend could play into the hands of smaller manufacturers making healthier products, such as fruit and vegetable juices, with no added sugar, but this could be short lived if the cola giants manage to develop more products to quickly defend their position in these emerging sectors.

There is not a lot of room for new entrants into the market at present. Foreign manufacturers will see a market with too much existing competition, and too slim a margin level, for many to consider investing in new market entry. China is expensive to work in now, and the rewards are not great enough for many. Also, many now realize that the number of Chinese with money to spend, and who can be easily reached, is nowhere near equal to 1 billion people. Indeed, if anything, China is becoming even more split into several regional markets. Foreign companies will also be aware that many other foreign entrants have now quit China, not so much in the soft drinks market, but certainly in sectors like beer, due to having made no money, and indeed lost quite a bit.

For Chinese companies looking to enter the market, the problem may not be local knowledge or a good product, suited to local tastes, but competing with the incumbent market leaders, and lack of investment capital. Most enterprizing manufacturers in China are now to be found in the private sector, and there is plenty of entrepreneurial spirit there, but the problem will be the credit squeeze on the lending banks, which will stifle lending to new private enterprise start-ups, particularly in a sector where it will be hard to prove that there is a viable business plan, given the low margins of the existing players, and the need to invest heavily in developing plant, marketing networks and distribution networks and transport infrastructure.

The market should continue to grow, and relatively strongly compared with markets elsewhere, but that will only be in line with general economic growth in China, not ahead of it. Meanwhile, costs of operation will most likely continue to increase, and thus margins will continue to be squeezed, especially if fuel prices rise, which seems likely as resources become scarcer, and more has to be imported. The price of oil will govern the price of energy to manufacture, the price of the plastic for bottles, the cost of transportation, etc.

Likewise, the increasing competition between retailers, leading to their own decreased margins, will lead those retailers to rely more heavily than ever on the "slotting fees", which, as the manufacturers compete more strongly for marketing space, are only likely to be pushed up.

We would expect to see continued consolidation in the market over coming years, with fewer smaller players, as many are bought up by larger competitors, especially if they own any half-way-decent or established brands that could beneficially add to an existing product portfolio, given the need to have a wider range of products in order to combat stagnation in any other sector. This would be even more the case were the issue of obesity linked to high-sugar-content drinks to become even an more contentious one.

Implications:

Uniqlo will have to respond to the Zara Effect in China

Zara is proving that the office ladies are the middle segment of the fashion business in Shanghai

At the same time the lower end retail chains are seeing sales collapse

Analysis:

The Zara Effect is in full effect in Shanghai: the Spanish chain’s stores are busy, ringing up sales and customers say they like what they see. After a decade when chasing the middle market of fashion in China was a disaster for retailers like Benetton, Zara appears to have found the niche market.

Shanghai’s Office Ladies (OLs) adopted Zara almost immediately after it opened in China with branches in Shanghai and Beijing. They immediately liked the brand’s sleeker cut that matches their generally slender figures better than most other brands; they liked that only 30% of the stock was made in China and most of the rest in Europe; they liked the simple but good quality black suits and white blouses that were practical but stylish. Zara of course is a world wide phenomenon offering the Prada look at a High Street price. In China this strategy works too but only recently. Until Zara the mid-market of Chinese fashion retailing was littered with the corpses of those who invested and then lost big – Benetton, Esprit etc. Asking Chinese women to pay over US$35 for clothes was tough – they either traded down to Giordano or one of the many other Gap-type stores or they saved hard and bought luxury brands. Zara has shown that women will pay between US$35-US$150 for items and that they will be loyal to a brand. Not everyone will be able to repeat Zara’s success – after all so much is down to the good collection – but more will try now the OLs are a proven fashion buying force.

Interestingly Zara took over one store vacated by Esprit in Shanghai, a retailer with a image problem in China. Many said Esprit failed at the location (Times Square on the city’s Huai Hai Lu) because it was too remote; Zara proves this wasn’t the case.

Now competitors like Uniqlo are fighting back – see linked story – aware that not only is Zara doing well but that Mango, H&M and others are coming up behind while the lower end chains such as Giordano and Bossini are seeing like for like sales collapse in China as they traditional customers upgrade.

Implications:

Retail Sales look substantially stronger of late;

The drop in Hong Kong unemployment is important but so is the Mainlander Effect

The Government now needs to ensure that the Mainlanders keep on coming to maintain growth.

Analysis:

The significant and seemingly real rise in retail sales in Hong Kong is partly down to more buoyant consumer confidence led by the fall in unemployment in the Special Administrative Region (SAR). However, never underestimate the Mainlander Effect in Hong Kong – the impact of Chinese Mainland spending in Hong Kong.

For those of us in the struggling high end and luxury goods market in Mainland China rising sales in Hong Kong are at least some consolation. The strategy of partly being ‘windows of introduction’ to Mainlanders who then avoid paying the high luxury goods taxes in China and purchase in Hong Kong at least pushes up Greater China or Asia-Pacific regional sales.

All the evidence from the luxury stores in Hong Kong is that the number of Mainlanders passing through and purchasing is getting stronger – that’s why Cantonese speaking shop assistants are being sent on Mandarin language courses, stores are offering an attractive RMB1=HK$1 rate and putting through Mainland credit cards has become more common.

It’s also true that combined tours taking in Hong Kong and the revived gambling Mecca of Macao are helping this trend. Even Hong Kong Disneyland has seen a bump in visitor numbers at long last after a disastrous period since opening. The Hong Kong government has rushed through legislation preventing the common rip-off shopping tours that had been putting Mainlanders off Hong Kong (guides take Mainlanders to stores and then insist they buy something and in return get a commission from the shop owner) – the Mainland Effect is full effect.

Implications:

Wal-Mart is looking to leap frog through acquisition while Carrefour is taking a more organic approach to growth in China;

Wal-Mart may find itself biting off more than it can chew and may have underestimated the challenges of changing a corporate culture in China;

Carrefour is proving once again that it understands China on a far deeper level than its American rival.

Analysis:

As usual Carrefour is demonstrating that when it comes to China the company still understands the need to remain calm and focussed in China and ignore all the hype. Stark contrast to Wal-Mart who’s attempted acquisition of poorly performing Trust-Mart may provide them with little more than another rod for their back in the PRC.

With the relaxation of retailing laws since China’s entry into the WTO it is tempting for foreign retailers to use their piles of cash to acquire and leap frog the competition – local and other foreigners. However, this is not an easy strategy or an instant panacea. Wal-Mart has had problems enough coping with the vagaries and preoccupations of British, German and Korean consumers without taking on the Chinese challenge too. Taking on a large Chinese (Taiwan funded) retailer will be a very stiff challenge – changing a work and business culture will be hard, long running and maybe nigh on impossible. That will do little but leave Wal-Mart with technically more flags on the China map than Carrefour but in reality with a bunch of under performing stores requiring vast amounts of attention and constant monitoring and intervention.

Carrefour understands that the real issues are not now rapid expansion but rather addressing the stagnation in same store sales affecting most retailers, including Carrefour, and getting average basket sizes up to a decent level. At the moment Wal-Mart’s average basket is pretty low – around RMB30 – and even local Chinese supermarket and hypermarket chains are doing better than that – Century Hypermarkets, part of the Shanghai-based Lianhua chain, has an average basket size of between RMB40-45. That’s still only around US$5.

Carrefour CEO Duran is right, as actually are the Best Buy executives who have been telling anyone who will listen that expansion will be slow and steady. In the long run organic growth is the way forward to a stable business. As usual in China it is essential to tune out all the background noise and the hype and concentrate on the business as it is and not the speculation about what it should be.

As for spending US$1 billion on a poorly performing provincial retailer in China? Well, Carrefour is probably keeping its powder dry – India is looming on the horizon!

Implications:

Starbucks is the latest in a line of retailers/caterers to sever the relationship with their Chinese partner.

Starbucks is doing this before it starts a major pre-Olympics expansion in Beijing.

However, questions remain over the long term viability of the coffee shop business in China.

Analysis:

What this basically means is that Starbucks has split with its partner in Beijing - Beijing Mei Da Coffee Co. Ltd. Beijing Mei Da were Starbucks partners from their first store in Beijing, back when a local partner was required. New regulations, following WTO entry mean that Starbucks can go it alone.

Severing relationships with old partners is popular at the moment among retailers and catering operators and not surprisingly so. As logistics and supply chain management have become easier and more streamlined, getting rid of the partner allows Starbucks to try and improve margins in its operations. The new system won’t necessarily mean any more customers but hopefully a little more profit per customer.

Beijing Mei Da was a good partner for Starbucks back in the late 1990s when they first entered the market as they had been supplying the Chinese capital’s 5 star hotels and some other establishments with coffee so there was a natural fit. Now Starbucks wants to expand significantly, pre-Olympics it seems the right time to break the relationship and take control of the supply chain itself.

Still some questions remain over the strength or otherwise of Starbucks China operations and their potential longevity. Many assume that Chinese consumers will take up coffee drinking regularly but others believe it is a passing fad and that with teahouses starting to look resurgent they may find their business hitting a wall outside those areas of wealthy Chinese and ex-pat residents. Already it is clear that traffic is slow at some stores and take-out business weak, but with the price of a cup of coffee not that different to the US or Europe (but with wages to staff significantly lower) the business can still be profitable.

Implications:

Wal-Mart is attempting to leap frog past Carrefour in China through acquisition

However, Wal-Mart is still some way from finding its feet in China and acquiring 100 stores while their own are still under-peforming may not be too smart

The acquisition (if it ultimately happens) raises a number of questions about Wal-Mart in China including where they will ultimately pitch themselves in the Chinese retail sector.

Analysis:

Wal-Mart has been playing catch up unsuccessfully with Carrefour in China for a few years now but so far they’ve neither managed to secure the best locations, roll out branches quickly enough or find a product offering as interesting to the Chinese consumer as their French competitors in the PRC.

So now it is time to short cut – and buy a local retailer to ramp up store numbers double quick. The details of the possible deal are all over the news – what has been a little less clear is the analysis of that deal.

Firstly, it is important to look at the current positioning of their target acquisition Trust-Mart – low end. The appealing thing about Trust-Mart is that they operate in 20 of China’s 34 provinces and regions – however, that coverage (while better than most) is a bit sporadic. Still, the major issue is where will Wal-Mart position itself?

Some of the analysis has been rather strange. Juliana Liu on BBC World (in Singapore) argued that Wal-Mart will concentrate on large stores where consumers can drive up in their cars, shop and then leave. This, she argued, was something you can’t do at other retailers in China and something Chinese consumers want. Well, not really. There are plenty of supermarkets and hypermarkets across China in the suburbs that you could drive to and shop. However, few people do thanks to low car ownership but also lack of storage space. Why buy in bulk when you have nowhere to put it. Fatal flaw in the argument. It is important to remember that across the local supermarket chains, Carrefour and Wal-Mart the average basket size in China is still only RMB40-45 in major cities such as Shanghai and lower than that in tier 2 and 3 cities. Hardly worth getting the car out to go and buy US$5 worth of groceries. BBC World’s analyst rather jumped the gun.

Wal-Mart’s positioning in China has been a subject of some debate. High end or low end? They’ve toyed with the Sam’s Club format (not at all suitable to China) and hypermarkets. As time has passed and experience grown they’ve understood what Carrefour grasped far quicker – that consumers often judge the quality of a supermarket/hypermarket by the fresh food component. Wal-Mart was not good at fresh food for a long time; Carrefour has always been strong in these categories.

The whole Wal-Mart/Trust-Mart deal has a fairly long way to go and not a few regulatory hurdles including the State Council which is not at the moment overly keen on foreign companies snapping up local companies (though Trust-Mart is Taiwanese-controlled). It may happen, it may not. The important thing is what Wal-Mart decides to do with any acquired stores and where they eventually opt to pitch their business.