The massive shopping mall in the Shanghai suburb of Xinzhuang is still under construction. Hand-written signs are plastered around the northern entrance notifying those without proper documentation that they will be refused entry.
A security guard with a Henan accent mans a small desk at the door and directs visitors to the southern entrance, where migrant workers hurry to plant trees and shrubbery beneath banners proclaiming the grand opening of the Xinzhuang Carrefour hypermarket.
Underground, the Carrefour, only 12 days old, is bustling.
A man in a pink polo shirt who gives his surname as Yin is buying household goods and cleaning supplies with his wife. He works for an IT company, and they are both in their late 20s.
“Our apartment is five minutes away, and we’ve been there two years,” he says as his wife fills up the shopping cart. “There are other places to shop in this area, but the selection here is much better.”
Price, he says, is not a big factor in his decision of where to shop.
A thousand miles away, in Nanning, Guangxi province, a woman named Jiang is shopping for handbags. Jiang, who co-owns a chemical plant with her husband, is a woman of expensive tastes: If it isn’t Louis Vuitton, Gucci or Chanel then it won’t do. Similar policies apply to the other items routinely found on her shopping list, namely designer clothing, jewelry, and cosmetics.
Jiang is also unworried about prices.
“My shopping habits may be influenced by my mood, but not by the economy,” she said. “I buy more when I’m happy and may buy less when I’m feeling down. But if I really love something, I will try my best to buy it.”
Lost in the doom and gloom of recent news about China’s economy – investors tormented by falling stock markets and softening real estate prices; producers squeezed by shrinking international demand and rising input costs – is the story of the Chinese consumer.
People like Yin and Jiang are helping to drive, and at the same time, change the picture of domestic demand. Amid a global economic slowdown, the Chinese consumer is resilient.
The numbers look clear enough: China’s retail sales volume, which rose 12.9% year-on-year in 2007 as a whole, accelerated to 14.3% between January and August of this year.
In value terms, retail sales grew 16.7% in 2007 but were up 21.7% year-on-year between January and August 2008. That’s despite a newly shortened May Day holiday cutting into a typically heavy shopping period, said Paul McKenzie, head of consumer research at brokerage CLSA.
In addition to the shorter holiday, McKenzie says there was some “temporary psychological fallout” from the May 12 Sichuan earthquake, which had a dampening effect on consumer spending. However, retail sales value growth rebounded to hit a 12-year high of 23.3% in July, and continued to post strong growth – 23.2% – in August.
That is not to say that these numbers tell the whole story. Official government retail sales numbers factor in wholesale and service trade figures, which serves to inflate the headline statistics. Nevertheless, the lines still point upwards: People are shopping.
Or, at least, most people are. One exception to the otherwise bright consumer picture is growth in the luxury goods segment. While a March report by consumer research firm Euromonitor listed rising demand for luxury goods as one of the key consumer trends to watch in China, other analysts claim demand for luxury goods and jewelry is slowing.
Underperforming capital markets have taken much of the blame for weaker luxury consumption growth. As Andy Xie, an independent economist, argues, the Shanghai Composite Index’s slide – it fell by more than 60% between January 1 and mid-September – combined with the woes of the property sector, have a real effect on luxury spending.
“So many profits were driven by the property market, not just for property developers but for other business as well,” said Xie.
Half-jokingly, he added that as small businesses profited from property investments, “a lot of small businesspeople essentially gave this money to their mistresses, who went out to buy LV bags and luxury cars … that’s basically the trickle-down economy in China.”
Although CLSA’s McKenzie suggests that any perceived slowdown may merely be on a comparative basis to the incredible growth seen earlier in the year, he doesn’t discount the idea of wealth destruction as a result of poorly performing markets. Residents of first-tier cities like Shanghai, who account for a sizeable proportion of luxury consumers in China as a whole, have larger relative exposure to stock and property markets, and are more highly leveraged – all factors that would contribute to lower spending in a bear market, McKenzie said.
However, not everyone subscribes to the wealth destruction theory, and not just because people like Jiang, the chemical factory owner, say they buy regardless of the state of the economy.
“This is a real big discrepancy in thinking between, on one hand, the financial community, and on the other hand, people who work in retail,” said Paul French, chief China representative for market research firm Access Asia and a regular contributor to CHINA ECONOMIC REVIEW. “We don’t see that negative wealth effect kicking in. People who link everything to stock market performance and property market performance see that link … but very few [urban consumers] are over-extended, and they’re not really worried.”
Instead, said French, luxury consumers are not buying less, but are buying less in mainland China. “That’s the big thing with luxury. You go down to Hong Kong and you’re getting it half price,” he said.
But if some affluent consumers are taking their money elsewhere, that effect is counterbalanced by the rise of a different consumer segment: the middle class.
Definitions of middle class consumers vary, but they can broadly be defined as those with household incomes of around US$4,000 a year. A typical middle class household can afford to raise a child, own an apartment and a small car, and have some money left over for discretionary purchases.
This description applies to a fast-growing segment of China’s population.
According to a report by forecasting firm Global Demographics, there are currently 212 million households in China earning between US$2,500 and US$10,000 per year. The firm expects that number to rise to 390 million in 2028, with 60% of those households making between US$5,000 and US$10,000. The total number of households in China is set to rise from the current 426 million to 549 million by 2028.
The growth of middle-class households is being spurred by rising incomes. Even as China’s consumer price index (CPI) growth spiked early this year due to rising food prices – hitting a 12-year high of 8.7% in February – wages have been growing more quickly than inflation. In 2007, urban incomes rose 12.2% in comparison to a CPI increase of 4.8%. Xie, the independent economist, said a tight labor market will ensure that high wages continue.
With food prices falling, and with CPI growth down to 4.9% year-on-year in August, real income growth will continue to rise, said Wang Qian, an economist at J.P. Morgan in Hong Kong. Retailers are rising to meet the challenge of winning consumers’ hard-earned yuan.
“What we talk about targeting is lifestyle brands,” said Janet De Silva, CEO of Retail China, a Hong Kong-based retail brand management firm that directly operates and staffs retail locations in China. The company’s research on Chinese consumers led it to bypass luxury goods, which it sees as already well-represented, and focus instead on introducing foreign brands to the middle-class market.
“[Our target consumers] are young professionals under the age of 40, many are first-time homeowners, many are looking to fit out their homes with furnishings and style,” said De Silva.
“They have a very contemporary global look … many of them are parents with needs for their children.”
Hoping to take advantage of the rising purchasing power of these young professionals, Retail China focuses on bringing new and different brand concepts to China. De Silva said that the introduction of La Vie En Rose, an upper mass-market swimwear and lingerie brand, is indicative of changing consumer preferences as domestic and international travel become more common.
By bringing unfamiliar brand concepts to China, the company is able to add what De Silva calls an “educational element” to shopping. Rather than simply selling products, La Vie En Rose salespeople are employed to help customers understand, for example, why certain kinds of swimwear work better for them, or how to combine different styles.
This approach also means the company’s brands can afford to charge a premium – one which consumers are increasingly willing to pay.
De Silva says Retail China’s brands are roughly 20-30% more expensive than domestic competitors. Even with that premium, Fruits & Passion, a bed, bath and household products brand, has seen annual sales growth of over 100%.
“For us, the challenge is how many stores we can locate in a particular market,” said De Silva.
Another beneficiary of changing consumption patterns is clothing manufacturer American Apparel. The company, which produces casual clothing in the US and is known for promoting progressive labor policies, has seen strong consumer interest in its Chinese stores.
“We are in China not just to sell a single piece of product,” said Wei Su, American Apparel’s China resident director. “We’re actually selling the American dreams and the American lifestyle … We’re selling our social responsibility and social awareness.”
Even the supermarket sector, typically known for its cutthroat competition, is benefiting from changes as consumers become open to premium product categories like organic foods. David Xie, a quality assurance manager at Wal-Mart China, said the company became aware of consumer willingness to pay more for organic foods in 2005. While overall sales remain low, Xie says the company is very optimistic about growth in the segment.
A report by the Boston Consulting Group sheds some light on the reasons for the success and optimism of upper mass-market retailers. In a 2007 survey of Chinese consumers, 59% said they planned to increase their spending within 12 months, with 11% planning to increase their spending by more than 20%.
In contrast, only 9% of consumers said they planned to decrease their overall spending. Furthermore, the desire to spend more on consumer goods exists across a wide range of product categories.
To the suburbs
As retailers discover that consumers are willing to trade up, they are not just looking for ways to attract new shoppers – they are increasingly going out to meet shoppers near their homes.
The mall around the Xinzhuang Carrefour, which will eventually host a Parkson department store, a B&Q home-improvement store and a wide range of smaller retailers, is part of a growing trend of retail properties expanding into middle-class areas in suburbs and second- and third-tier cities. Yin, the shopper at the Xinzhuang Carrefour, said that with his job and apartment both in Shanghai’s suburbs, he ventured into the city center once a month at most.
“The suburbs are no longer just dormitory communities and Americans who don’t really want to be in China,” said Access Asia’s French. “There are malls out in these places and everyone’s opening … It’s pretty much the same price points as downtown. As far as the consumers are concerned, it’s not that different.”
Property developers, encouraged by lower land prices, are leading the charge. Of the 13 new malls and retail properties that Singaporean developer CapitaLand plans to open in China in 2008 and 2009, 12 are in suburbs and second- and third-tier cities such as Yiyang in Hunan, Yangzhou in Jiangsu, and Yibin in Sichuan. As malls move into less-expensive cities and suburbs, retailers benefit from consumers with more disposable income due to lower housing costs, and improved margins due to lower rents.
Lines of credit
Key to the growth of shopping malls is the larger demographic trend of urbanization. As CLSA’s McKenzie points out, China is still only 40% urbanized and is adding 10-20 million people to its cities each year. He sees this as a powerful driver of many consumer patterns.
One of these patterns is consumer credit growth.
“Your average Chinese household is just massively under-leveraged by any standard,” McKenzie said. The rapid rise in credit card ownership and usage over the last five years, and mortgage growth – still strong despite a slowing property market – is changing that.
“If China got to even a fraction of where Western consumers are indebted, that would underpin very high levels of consumption,” McKenzie added.
But there are obstacles in the way.
Despite the growth of an increasingly spendthrift Chinese middle class, the fact remains that Chinese consumers, as a whole, remain very price-sensitive.
“People always moan that the queues are long [in large supermarkets like Carrefour] even though people aren’t buying much. And you will be in a queue behind someone buying two cans of Coke because they’ll save 50 fen,” said French.
The wealth gap
High sensitivity to prices reflects an economy where wealth distribution remains very uneven.
“Basically, if you want to reach half the households earning over RMB80,000 (US$11,690), you only have to be in 11 cities in China,” said Clint Laurent, chief executive of Global Demographics.
At the same time, there are still more than 197 million households earning less than US$2,500 per year. While the percentage of such households is shrinking, Global Demographics predicts they will still number 103 million in 2028. These households will make up 51% of total rural households – down from 80% today – but only 3% of urban households.
But the large raw number of low-income households is overshadowed by the overall trend: China’s consumers are earning and buying more, and Beijing will likely support continued growth as it tries to build up the market at home to guard against potentially weak exports. CLSA’s McKenzie points to recent tax cuts and increases in tax thresholds, as well as reductions in import duties on consumer products, as examples of moves conducive to consumers.
“You will see consumption-friendly policies by the government over the next decade,” he said.
Xie, the independent economist, believes that higher consumption could strongly benefit China’s economy: If the consumer sector represents half of GDP and it grows at 10% a year, this equates to a 5% annual boost for the economy.
Logically, a sharp downturn in consumption would have a similarly sharp negative effect on the economy. But few market watchers expect this to happen.
“There’s nothing Chinese about China,” said Access Asia’s French. “They’re just people, and they’ve got a certain amount of money in their pockets. They’ll consume more when they’ve got more money in their pockets.”