China's population is a magnet for foreign and domestic companies alike, but unlocking the consumer at the heart of the Chinese psyche remains the number one challenge. Shaped by Confucian culture and authoritarian rule, consumption habits have historically conformed to a model of buy what you can, when you can, as cheaply as you can. Chinese companies, operating under a system that defined property as a common good, have had little incentive to distinguish themselves from their competitors.
But as the government looks to domestic consumption to fuel the next phase of the country's transition into a global economic powerhouse, the opening up of domestic markets to foreign interests has seen China's bland retail spaces rapidly replaced by branded ones. The battle to help the country spend is picking up pace as companies rush to imprint their vision on to the shoppers' subconscious.
As Tom Doctoroff, Greater China CEO of advertising giant JWT, explains, this battle is taking place in a market that poses truly unique cultural, demographic and geographical challenges. Those companies that fail to unhook themselves from the belief that the Western way is the only way, will continue to struggle. "People walk in comforted by their own beliefs; they are not coming in arrogant so much as oblivious," Doctoroff said.
The stakes for all those involved in this brand war are huge. With more than US$2 billion in sales annually, China already accounts for about 12% of global sales in high-end fashions, accessories and other luxury goods. Only Japan with 41% and the US with 17% spend more.
Despite already operating from a huge consumption base, most experts agree the well has barely been tapped. According to Ernst & Young research, the luxury goods market is expected to grow 20% annually until 2008 and then 10% a year until 2015, reaching a total value in excess of US$11.5 billion. Responsible for 29% of global luxury goods purchases, Chinese consumers will be as influential as the Japanese.
More than 300,000 Chinese already have a net worth of more than US$1 million and the mainland's millionaires control about US$530 billion in assets. But it's not just the high-end consumers that have potential. In its 2005 Global Retail Development Index, A.T. Kearney estimated that by 2020, 40% of China's population, approximately 468 million people, would be categorized as middle-class.
The study concluded that China's retail market is the largest emerging opportunity in the world, citing a value of more than US$628 billion, and a growth rate in excess of 9% per year. This estimate is conservative; China Statistics Bureau figures show retail spending grew 12.9% in 2005 to more than US$800 billion.
Foreign activity in the sector has risen with the easing of government restrictions. In December 2004, foreign companies were permitted to open wholly owned stores rather than rely on joint ventures. They now have the chance to boost their high street presence as they did their ad expenditure after the ban on commercial advertising was lifted in 1979. China's advertising industry has sprung from nothing to overtake Italy as the world's third-largest in 2005, and is set to steal second spot from Japan by 2010.
The latest figures from Nielsen Media Research show that China's ad spending in television, newspapers and magazines hit US$39 billion in 2005. This represents an increase of 21% on the previous year, against a 15% growth rate for the entire Asia-Pacific region. TV attracted US$30.7 billion – almost 80% of the total – making China the world's second-largest television advertising market. (See: New media: the medium is the message).
But is this money well spent? In a January global equity research report, UBS warned potential investors not to pay more for a Chinese stock just because it comes with a brand. "Companies with branded products in China do not make superior profits," the report said. It found the fragmented retail market meant price and distribution were more important to success than marketing. "In our view, a wiser strategy would be to save advertising dollars and use the money to motivate distributors," the report concluded.
The ACNielsen retail census shows how fragmented the retail sector is. There were 4.6 million retail outlets in China in 2005, but the top five fast moving consumer goods (FMCG) retailers only accounted for 4.36% of total FMCG sales. Although this had increased from only 2% in 2003, it still leaves huge room for market consolidation, especially when compared to the 94% market share of the top five Australian retailers, and 74% share of Hong Kong's top five.
China is also fragmented geographically, with 108 cities having urban area populations in excess of 1 million people. Combined with poor transport infrastructure and huge regional disparities in purchasing power, consumption, tastes and education, substantial barriers exist to those trying to create a nationwide brand. China can be characterized as one nation, but not one market.
Conway Lee, retail and consumer products industry specialist at Ernst & Young, said the fragmented and regionalized market was the primary obstacle to domestic companies looking to develop a premium brand. It also gives established foreign brands a valuable head start. "There are so many small players in the market. They need to consolidate through mergers and acquisitions," he said.
Consolidation is happening. Although the number of retail stores in China only increased 2% during 2005, the number of modern trade retail shops – hypermarkets, supermarkets and convenience stores – increased by 25%, with one new outlet opening every minute somewhere in China. As an example, Lee singled out Wumart, Beijing's largest supermarket, which has been acquiring competitors and consolidating the fragmented retail sector.
As the sector consolidates, advantages in distribution and pricing enjoyed by domestic players are likely to become less important. This makes developing a brand identity essential for Chinese companies hoping to survive, according to JWT's Doctoroff. "Distribution is for awareness and awareness gets you scale, but brand gives you profit and premium," he said. "They are operating on low margins so they need to start pulling their brands up."
ACNielsen brand equity research, which analyzes three measures of customer loyalty to a brand – is it a favorite brand, would they recommend it and would they pay a price premium – shows how high the stakes are. In China, unlike most other countries including the US and EU nations, brand equity distribution is skewed to either end of a normal curve.
"In China, brands are working at both ends of the spectrum," said Millette Tsai, ACNielsen customized research director. "There are a lot of brands out there competing on price or just being in the market and they are not particularly strong but they do exist. China also has the highest concentration of [brands with high brand equity] that are probably premium price and doing well."
Tsai's brand equity research showed that local companies were starting at a disadvantage. "Of course I can think of a few local brands that are strong in their specific categories," she said. "But overall, from the figures I have, there is a very big disparity … the foreign brands have a much higher equity than the local brands."
Foreign brands had particularly high preference in automotive, durables and fashion and accessory categories, while local brands retained strong preference in food. The split can be put down to the way Chinese people view brands, according to Doris Ho, principal consultant at Asia branding consultancy Sprout Brands. "In other markets brands measure quality and help people make choices. Brands in China are status enhancers," she said.
Though food quality is important, it is largely consumed in the home, so Chinese consumers are unwilling to pay a premium for a status brand; a car, on the other hand, is a symbol of status outside of the home, so brand becomes highly important.
Foreign brands are willing to spend money to secure this brand advantage, Nielsen Media Research advertising figures show. International consumer brands were the fastest movers in China's advertising market in 2005, with five represented in China's top 10 advertiser list last year, up from two the year before.
Cosmetics brand Oil of Olay retained the top spot after boosting its ad spending 9% to US$781 million, while Rejoice, Crest and Colgate took the next three spots, their expenditue rising by high double-digit percentages. The top domestic advertiser, pharmaceutical firm Gai Zhong Gai, was left behind in fifth place.
Presence on the ground is also important, with foreign brands rushing to establish domestic outlets and production and R&D facilities in China. US denim brand Diesel and Japanese women's chain Lecien Corp have both opened stores in Shanghai, and Saks Fifth Avenue plans to follow suit. Italy's Pianegonda now sells jewelry in Beijing's Parkson Department Store.
L'Oreal has opened a research centre in Pudong to study the Chinese skin, and Japan's Kanebo Cosmetics has launched its Freeplus skin care line at 130 drug stores throughout China, aiming to reach an additional 350 stores by 2008.
Locals hit back
Domestic firms are fighting back, expanding production and distribution, often in simultaneous cooperation and competition with joint venture partners. Cone Denim Jiaxing, a joint venture of International Textile Group and Novel Enterprises, has signed a US$35 million loan deal with Bank of China to upgrade its factory. EBT Mobile China will sell mobile phone and wireless services at outlets in 10 Metro cash-and-carry stores after a deal with Germany-based Metro AG, which has 29 outlets in China. Meanwhile, China Paradise Electronics Retail Co has set up a 50-50 joint venture with Dazhong Electric Appliance to operate home appliance stores.
Government-owned Shanghai Automotive Industry Corp has also announced plans to make its own high-end sedan to compete directly with offerings from its joint venture partners General Motors and Volkswagen AG. Michael Dunne, president of consultancy Automotive Resources Asia, described it as a "watershed" moment for the auto industry.
"The Chinese formed joint ventures for one purpose: to learn how to do it themselves one day," he told the Wall Street Journal. "That day is here."
It is this meeting point between the aspirations of local companies and those of global brands entering China that excites Doctoroff. "Local brands and multinational brands have basically been existing in two parallel universes," he said. "They have been two ships passing in the night."
Multinational brands tend to operate at the higher end of the Chinese consumer class with desirable products that are beyond the reach of the majority of China's population, JWT's Doctoroff explained, while local products have been mass-targeted, low-cost and functional (See: Faking it: theft hurts?). It is at the intersection between mass and premium that the competition for Chinese consumers will be won or lost, he said. "Mass premium is accessible to both local companies and multinationals; that's where the battle is."
Doctoroff argues that there are several ways to implement the mass premium strategy, including establishing price tiers or diversifying product ranges. Colgate-Palmolive leveraged its powerful Colgate Total brand by extending its equity to the cheaper Colgate Strong and Colgate Herbal lines. "Only 3% of its 25% market share is the top range, but still the only thing they advertise – and this is the important point – is the top brand," Doctoroff said.
He cites Nokia as another successful example of the mass premium strategy – "you don't build your image with your US$80 Nokia phone but you still have a consistent design signature" – and Whisper Cotton as a model of what not to do. "Whisper is an adulterated master brand," he said, after the company introduced low-cost sanitary napkins using cotton instead of synthetic materials. "Everybody knows cotton is cheap and everybody knows local brands are cotton. They degraded and cheapened the image of the company."
The mass premium strategy requires a delicate balancing act. Brands need to appeal to a wide demographic without sacrificing premium appeal, otherwise they are likely to find themselves competing directly with Chinese mass brands at the bottom end of the market.
"You are diverging from what [your positioning] would be in developed markets and in that sense you are adulterating your brand and brand values," Doctoroff said. "But you are not whoring yourself down with the lowest dregs of society. This is a very, very thin sheet of ice that people are walking on but if you go gently, gracefully, you can skate across."
Despite the difficulties facing global brands entering China, the challenges are bigger for domestic companies starting out on the brand path. Ernst & Young's Conway Lee believes Chinese consumers used "Western" as a proxy for brand values, creating huge barriers for domestic brands to try and overcome. "Local brands are catching up but in general Chinese consumers prefer Western brands because it is a guarantee of quality," he said.
Globalization complicated matters. Building global brands is highly competitive, demanding more rigorous management today than when Japanese and, more recently, South Korean companies undertook the brand challenge at comparative levels of their economic development.
But Lee predicts China will be successful with Chinese entrepreneurs willing to spend money on consulting. "They are aware of the importance of brand strategy and they are working on it," he said. "They use a lot of consultants and these people can help them speed up development."
For the new China, winning at home is not enough. The government initiated a "go-out" policy in 2002 to create between 30 and 50 Chinese companies able to compete with global giants such as Coca Cola, Microsoft and Wal-Mart by 2010. Four years on, little progress appears to be made, with only two companies coming close to being able to claim even a modicum of global recognition; consumer electronics giant Haier and computer maker Lenovo.
On the face of it, China's leading maker of fridges, washing machines and air conditioners looks like a global success. Haier holds market shares of 20-70% in most home appliance categories in China and has used this strong domestic base to launch a global assault. It now has bases in more than 100 countries and overseas sales have broken the US$1 billion mark.
Haier and higher
The company claims 30% of the market for small fridges and half the market for wine coolers in the US, and a 10th of Europe's air-conditioner market. Haier is now the world's fourth-largest white-goods maker behind Whirlpool, Electrolux and Bosch-Siemens and ahead of GE.
But aside from a cult following among American college students who chill their beer in its mini-fridges, Haier does not have an established brand abroad. The great unknown is whether it, or any other Chinese company, can build one.
Mark Thomas, managing director of sports marketing consultancy S2M, said Haier is closer than any other domestic company but that it still needs to sponsor a global platform. "They have presence, they have manufacturing, they have distribution networks around Europe and North America, but sport would be very, very good for them," he said.
Thomas cites Japanese and Korean companies like Toyota and Kia, which have become truly global brands on the back of aggressive sports sponsorship, as role-models for Chinese aspirants. "They have outstretched themselves and used sport as the primary carrier to globalize their brand," he explained.
In March S2M organized a sports sponsorship conference in Shanghai, which drew together a who's who of companies looking to leverage their brands in China through sport, including global giants Coca-Cola and GM. The conference was particularly relevant given the approaching 2008 Olympic Games in Beijing, which have been widely touted as the big opportunity for Chinese companies to take their brands global, and for global companies to make their mark in China.
According to Thomas, the brand-building potential of the Olympics is over-hyped. "There is no brand value in sponsoring the Olympics; everything depends on how you activate it," he said, pointing out that Olympic venues are advertising-free zones. Simply buying rights is not sufficient in a media environment in which brands use creative marketing campaigns to ambush official sponsors.
Complicating factors, only top-level Olympic sponsors have the right to globally activate their brands. Second-tier sponsors are restricted to domestic activation only, which is fine for global brands seeking a presence in China, but of little use in realizing China's global brand ambitions.
Thomas contends that the government gets in the way of Chinese companies leveraging their brands effectively. Rather than evaluating sponsorship on commercial imperatives or brand objectives, most Chinese organizations "base it on whether they get a phone call from someone in high government office," he said.
The exception is Lenovo, which has secured top-level sponsorship of the Games. "The other Chinese companies are basically being led down the garden path by the Chinese government," Thomas said. "Lenovo has seen it strategically. They need a global property to carry their brand to a global audience so the Olympics is a great platform for them."
Cynics accused the company of buying a brand name when it purchased IBM's ailing PC division in December 2004 for US$1.75 billion, giving it access to the US-based giants' "Think" brand. Since then it has shown its desire to establish its own uniquely Chinese identity, launching a Lenovo 3000 range of computers in 10 cities worldwide in March. Jeff Dudash, a Lenovo spokesman described the launch as "our coming-out party". "The Olympics got our name out in front of the world, and these will be the brand-name products we'll be introducing with that," he added.
The company can be expected to unleash unprecedented publicity in the run-up to and during the Olympics, using a two-tiered approach based on the strong "Think" brand for corporate sales, and a "quality at a low price" strategy to market its Lenovo 3000 series to small businesses and individual users.
With only a five-year contract to use the IBM moniker, the success of the Lenovo 3000 brand is critical to the company's fortunes. Given the amount of attention that will focus on Beijing in 2008, Lenovo could be just a successful marketing campaign away from becoming China's answer to Sony. But marketing is not enough; the question mark is over whether the company's homegrown product range will support its brand aspirations.
Many experts are skeptical of China's ability to build strong global brands at present. Doctoroff said there were two basic ways to export a brand. The first, which only has potential in emerging markets, is to compete on price and value. "They can do that now; just ship it and make it good quality at a good price," he said. But to target developed markets, they need to first establish a brand in China "that is not just a reliable Chinese brand but that has real values that are relevant to different countries" and then start marketing it.
On this count, Lenovo has failed its first test, with BIOS magazine dismissing the Lenovo 3000 C100 laptop as "a poor substitute for the IBM ThinkPad range" while a PC Magazine reviewer described it as "capable" but undistinguished, and generally less attractive than the popular value offerings from Acer, Dell, or HP.
"You cannot ship one brand right now to America and have it succeed on anything but the cheapest possible price," is Doctoroff's stark assessment.
China's position as a global economic powerhouse has everything to do with its success at making and exporting other countries' products, but very little to do with its ability to create. Beijing 2008 is part of a concerted government effort to shake this tag and earn a place at the top table of global innovation.
But while it focuses on the world stage, the real battle is taking place at home in the world's fastest-growing consumer market. Chinese brands will come given time, but first they have to win the hearts and minds of China's consumer classes. At the moment, they have a lot of ground to cover if they hope to catch the foreign brands and establish a global launching pad.
Glory at home will belong to those who are the first to work out the rules of the game, and the quickest route to the top. "CEOs know China is becoming important but they haven't even started to open their eyes about what is going on here," Doctoroff said.
"So it is really an exciting time for us that are situated on the mountain to be giving some advice."
New media: the medium is the message
Nielsen Media Research figures do not tell the whole story of advertising growth in China. Its figures do not factor in new media avenues, which have significant potential for growth given the relatively high-cost of traditional advertising in China.
Despite disposable income being much lower in China, television advertising prices are similar to developed markets when cost per thousand views (CPM) is taken into account. China's CPM index is around 10, against 100 in the US and 194 in the UK. The high cost is due to mass-targeted Chinese programming making it all but impossible for advertisers to target desired demographics exclusively.
But as Tom Doctoroff, Greater China CEO of advertising group JWT, explains, alternatives to TV are few and far between. "Media is expensive and it is just a reality that you have to come to terms with."
The reality is changing, though. At the forefront of this new media revolution is Shanghai-based Focus Media. The company has developed a network of flat-screen video display units for use in elevators, shopping centers and high-traffic public places, enabling advertisers to directly target China's affluent where they live, work and shop.
By late 2005, the group reached approximately 40 million high-income individuals in 58 major cities through more than 50,000 screens. Focus Media recently took over its main rival Target Media Holdings for US$325 million, giving it a 90% share of the digital display advertising market. Even as it signs up a portfolio of leading customers – including Nokia, McDonald's and Procter & Gamble – the company has not been shy about using its dominant pricing power position to raise advertising rates by 15-30%.
The Internet also provides significant advertising opportunities. Studies show that China's Internet users spend more time online than they do with TV and newspapers. Internet users grew 18% last year to reach 111 million and this has in turn led to an increase in the advertising revenues generated by online portals like TOM Online – up 21.5% to US$9.21 million – and search engines like Baidu.com – up 187.6% to US$38.1 million.
Increasingly, companies are also recognizing the advantage of in-store activities, ACNielsen Customised Research director Millette Tsai said. "More and more companies are looking at how consumers actually make decisions and a lot of it is based on the shop floor."
JWT has also made a significant move in this direction, purchasing field-marketing company Always Marketing Services to support below-the-line activities and ensure strong synergies with above-the-line advertising.
Faking it: theft hurts?
Piracy in China is said to cost the movie, software and other copyright industries more than US$2.5 billion a year, while US manufacturing and consumer goods industries could be losing five times that amount.
But as Bob Kwauk, managing partner of Canadian law firm Blake, Cassels and Graydon's Beijing office, points out, every fake Gucci sold in a China does not represent a sale lost for the Gucci company. The effect on the brand can be important, though. "There are many ways a brand can be damaged," he said. "High quality exports to the US will hit Gucci's revenue and if the quality is inferior it will affect Gucci's reputation."
There is a general agreement among brand experts that counterfeiting exists because Chinese consumers lack brand sophistication. Doris Ho, principal consultant at Asia branding consultancy Sprout Brands, believes it will become easier to curb when consumers begin placing a higher value on brands.
"Once it gets like Hong Kong, where the value on brands is much higher in terms of the promise it brings, the kind of image that is built up and the consumers' association with it, it becomes easier to arrest," she said. "A group of people will emerge who will pay top dollar for the real stuff."
Plusses of piracy
It can be argued that fakes are bringing that day closer, as they build brand awareness. "I know that I am wrong but I just don't see it hurting," said Tom Doctoroff, Greater China CEO of JWT. "Anybody that can afford the real thing won't be caught dead with a fake."
Strong brands help consumers go from fake market to real deal by providing limited access to the brand. "It is a brilliant strategy the way you throw some crumbs to them, such as a Gucci coin purse, so they don't think about buying a fake," said Doctoroff. "Give people a bone and make sure that your brand has clear values so that the existence of a fake market doesn't tarnish it."
More importantly, fakes help weed out the weak brands from the strong. "The best insulation from fakes is robust brand equity," he said. "If you fall into the Rolex trap, where the brand has no specific value, then fakes hurt a lot."
Decision time: to shop or not?
Arecent McKinsey survey shows that spending power hasn't yet caught up with buying desire as Chinese consumers wage war over the eternal question: to spend or save?
The survey, conducted in 2005 on 6,000 Chinese households in 30 cities, showed that consumers had a strong appetite for consumer goods in the short term, with many including big-ticket items on their shopping lists for the next 12 months: 8.5% said they intended to purchase a new home; 8.1% said their intended next major buy is a flat-screen television; and 2.4% said they plan to acquire a car during the course of the year.
The survey confirms rapid growth of consumerism in smaller cities and towns, with some products on more shopping lists in rural areas and midsize cities than in the largest cities where the market is becoming saturated. "What we are witnessing in China is the fastest and largest creation of a new consumer class in the history of the world," said Kevin Lane, a partner in McKinsey & Company's Shanghai office. "The survey's discovery of such strong demand in China's up-and-coming urban areas underlines the importance of this new battleground for multinationals and local competitors."
But the survey also found that the absence of a strong social safety net also has a profound influence on shopping behavior, with just 37% claiming confidence in their economic future.
On average, respondents saved a quarter of family income, with 50% citing the need to put money aside in case a family member fell ill, and 43% citing retirement. Among the one-third of respondents whose income had increased over the past year, nearly half put all or most of the extra money into savings.