Hypergrowth for China's hypermarkets

To capture a slice of this huge and lucrative market, foreign retailers must understand that China is different, writes McKinsey & Co.

Hypermarkets are poised to emerge as the winning format in China's fast-growing retail sector: they not only have become a hit with the country's shoppers but also generate better margins than alternatives such as supermarkets and department stores. Domestic and multinational retailers that intend to open hypermarkets there should take note, however: China is different.

The entire retail sector is growing by 7 per cent a year in China, much faster than it is in most other developing countries. With US$405bn in revenues in 2001, it was 56 per cent larger in China than in the remainder of Asia's major markets (excluding Japan) combined and could reach US$713bn by 2010. Although hypermarkets still account for less than 2 per cent of all Chinese retail sales, revenues from these stores have been growing on average by 64 per cent a year – more quickly than the retail sector as a whole. And although the pace of growth is slowing, sales from hypermarkets will continue to expand at the fairly rapid clip of 25 to 30 per cent annually through 2010. (According to one standard industry definition, hypermarkets are at least 2,500 sq metres in size and offer a wide assortment of food and non-food items).

China's hypermarkets, much like their counterparts in the West, can afford to charge lower prices thanks to the high volumes of goods they move; sales per square metre in Shanghai's hypermarkets are more than twoand- a-half times those of local supermarke t s . Prices tend to be 10 to 15 per cent lower than they are in department stores and supermarkets, and some companies, such as the Chinese hypermarket operator Nonggongshang, offer prices that are as much as 20 per cent lower. Larger sales volumes and lower purchasing costs enable hypermarkets to negotiate better prices from their suppliers – savings passed on to customers. Some foreign hypermarkets operating in China earn margins of 3 per cent, as opposed to the 1 per cent typical of most locally managed supermarkets.

What is so different about hypermarkets in China? Unlike their European and US counterparts, which are generally found in suburban areas, they tend to be located in densely populated cities because so few people own automobiles. This positioning helps hypermarkets to establish a local base of recurring customer traffic. With space at a premium, hypermarket operators in China have had to tweak the warehouse-style, single- level model of the West by creating multilevel stores. And whereas customers in the West tend to load up on goods once a week, the Chinese visit their local hypermarkets more frequently and spend less money during each visit. Smaller shopping carts are one obvious modification for local conditions, and the low number of cars has inspired such creative services as the shuttle buses that Wal-Mart offers its customers in Shenzhen.

In China, daily trips to buy fresh groceries from traditional wet markets and supermarkets are the norm. Although hypermarkets increasingly compete head-to-head with them by offering a wide variety of fresh or packaged food, the big stores differ from these rivals in a very important way: thanks to much higher customer traffic, food sells more quickly, enabling hypermarket operators to stock only the freshest produce and meats.

But sourcing can be a difficult challenge for foreign operators trying to apply the hygiene standards of the West as well as for local operators hoping to match the foreign competition. A Chinese hypermarket may stock 35,000 different items, and it is often difficult to trace goods back to their original producers. Unfortunately, the hygiene conditions of farming operations in China vary widely, and regulations governing the use of pesticides are lax at best. Finding the right location is another key challenge as competition in top-tier cities such as Shanghai and Guangzhou rapidly heats up. An enormous opportunity remains, however, in second-tier cities such as Chengdu, Dalian, Nanjing and Tianjin. According to our estimates, the 33 cities in this category could accommodate up to 800 additional new hypermarkets by 2010.

Although multinational and local hypermarket operators face strategic and operational challenges, these obstacles don't seem to be holding them back. Carrefour, a pioneer in the market, has opened 31 stores since 1995 and plans to open an additional 10 every year. Until other formats respond to the challenge, hypermarkets will continue to increase their share of this enormous market.

This article was written by Alvin Miu, a consultant and Jacques Penhirin, a principal in McKinsey's Hong Kong office. It was originally published in The McKinsey Quarterly, 2003 Number 2, and can be found on the publication's website, http://www.mckinseyquarterly. com. . 2003 McKinsey & Company. All rights reserved. Reprinted by permission.