Size matters

In May, the Shanghai government announced a master plan to merge a department store group, retail grocery chains and a logistics business to form Shanghai Bailian Group, with annual sales of Yn70bn. The Shanghai Friendship Group – which includes the Lianhua supermarket chain – and the Hualian Group supermarket chain were among the merged companies. The objective is to create a food retailer capable of competing with the likes of Carrefour and Wal-Mart.

In theory, the idea has merit. China's food retailers are far too small to battle the international giants, which also have superior know-how in the areas of management, logistics and information technology. To be sure, local retailers have crucial advantages in that they know the local market extremely well and have strong local government support. But in China's rapidly changing consumer market, sophisticated management and IT systems to track those changes are increasingly important.

"Local retailers lack the technical competencies – category management, supply chain management, marketing and promotional strategies, and information technology systems. There is definitely a gap here that has to be closed for Chinese retailers to compete with international retailers," says Richard Yeung, chief executive of Convenience Retail Asia, which runs the Circle K franchise in Hong Kong and the mainland.

Breathing space

Protectionist policies that limit the expansion of foreign retailers have so far allowed domestic companies some breathing space. But the clock is ticking – according to China's WTO agreement, in 2004 all geographical expansion restrictions will be lifted on foreign retailers.

Few are ready to write off Chinese food retailers as has-beens, however. Even if foreign companies manage to dominate the hypermarket sector, domestic firms are likely to remain a force in the smaller formats, analysts predict. "I'm a believer that there will be some strong Chinese retail players at the end of the day," says Shanghai-based McKinsey & Co partner Jonathan Woetzel.

China's largest retailer, Lianhua Group, is perhaps best positioned to make it in the increasingly competitive food retail sector. In 2002 Lianhua achieved revenues of Yn8bn and profits of Yn128m, says Ge Jianping, one of the group's managers. Equally important from a cash point of view, in June Lianhua listed on Hong Kong's stock exchange to an enthusiastic response, raising HK$581m (US$74.5m).

Expansion on all fronts

That gives Lianhua a war chest to execute its offensive strategy against the foreign invaders – massive expansion on all fronts. Starting several years ago, Lianhua ventured out of the basic supermarket format, adding hypermarkets, convenience stores and discount stores. Currently the company has 828 supermarkets, 11 hypermarkets, 1,045 convenience stores and, through its joint venture with Carrefour, four Dia discount stores. By 2008, Lianhua aims to have 8,000 outlets nationwide and annual sales of Yn80bn.

Ge says management is one of Lianhua's strengths, based on the fact that the company began opening supermarkets in the 1990s. But running a supermarket and managing four different kinds of stores, with different product mixes and customers, will be quite a challenge. "Every segment is quite unique and it will require some focus to stay competitive" says Yeung.

With details of the planned merger still sketchy, neither Hualian nor Lianhua have anything to say about the wisdom or desirability of such a move. But the government has little choice, points out Woetzel. "It is important to have strong champions who can achieve economies of scale to compete," he says. More than bigness is called for, however. "To win, you need to execute and that is around performance management, which has been one of the challenges of Chinese companies," he says, singling out financial incentives as one area that needs improvement.

Innovation is another area where Chinese retailers fall short, says Christopher Torrens, managing editor at Shanghai-based market research firm Access Asia. "So far, Hualian and Lianhua are failing to innovate in their stores and instead are copying concepts such as the creation of the wet-market layout in Carrefour's Gubei store," he says.

Focusing on each segment may be particularly tough in the next few months, as Lianhua may have to concentrate on merging with competitor Hualian rather than running its diverse businesses. Though Lianhua's Ge says Bailian has promised "not to interfere with the running of Lianhua", press reports say the two will be merged under the Lianhua brand.

Wal-Mart and Carrefour are relative newcomers to the China retail market, but they already have stores across the nation, which points to another weakness of most Chinese retailers – they are still regional in scope. Lianhua's numerous stores are concentrated in the Yangtze River Delta region of Shanghai, Zhejiang and Jiangsu. By comparison, Wal-Mart has 28 stores in 12 cities nationwide including 22 Supercenters (hypermarkets), four Sam's Clubs (discount stores) and two Neighborhood Markets, a supermarket format introduced in January 2002. Carrefour has 40 hypermarkets in 21 cities and four Dia discount stores opened in partnership with Lianhua.

Looking for overseas opportunities

By contrast, some local retailers are almost too ambitious in their expansion plans. Hualian has more than 1,200 supermarkets spread out over 10 provinces, and more than 20 convenience stores, says spokeswoman Huang Haiyan. Rather than simply focus on expanding its national presence, Hualian is looking to expand overseas. It plans to open a store in Bucharest, the capital of Romania, China Dailyreported in May. "Carrefour and Metro have opened stores there and enjoyed brisk business, but there's still market room for us," Hualian official Qian Shuren was quoted as saying. Huang confirms that Hualian did have overseas expansion plans, "but they haven't been implemented yet".

Such long-term planning may now have to be put on hold, however. Bailian has yet to announce specific steps it will take regarding the merger of Hualian and Lianhua, says Huang.

A logistics company, Shanghai Materials Group is part of the new Bailian, and it is expected to carry out the important function of sourcing in bigger volumes and moving goods around the country more efficiently. But the Chinese company will still need to improve its store layouts and merchandising to appeal to China's ever-pickier consumers.

"As consumers become more well-off, they will begin to enjoy the shopping process more, and look for a more pleasant shopping environment and greater product/brand choice," says Torrens.

Access Asia's research also shows that Chinese consumers are buying fewer but more expensive food items and more fastmoving consumer goods such as clothing, footwear and personal products. From 1996 to 2002, food dropped from 50.12 per cent of total purchases to 49.98 per cent. This is less than 1 per cent, but still significant in dollar terms considering China's retail sales topped Yn3,800bn in 2002, according to Access Asia. The trend is most pronounced among wealthier consumers in China's urban areas, where sales of fruit and vegetables are slowing, while those of non-traditional items like dairy and bakery goods are rising. Consumers are also spending more on sweets and savoury snacks.

A keener eye for merchandise would also help Chinese retailers compete. Wal-Mart and Carrefour excel at the one-stop-shopping concept – allowing customers to buy not only food, but dry goods and even appliances all under one roof – and thus can retain customers even as their buying habits change. Chinese retailers are still working on the right merchandise mix for these kinds of stores, says Paul French, Access Asia's publishing director.

When expansion restrictions are lifted in 2004, local retailers will still be competitive in the supermarkets and convenience store segments. They should have a good chance to be the leading retailers in those formats, says Beijing-based analyst Guo Haiyan of China International Capital Corporation. "One of the local players' competitive strengths is location because they were the first movers [in those formats]," she says. "In the hypermarket sector they will meet intensive competition."

Foreign players will be playing catch up for some time. Even though Wal-Mart made a move into the convenience store format in 2002 with its Neighborhood Markets, there are only two of the stores in China right now. Carrefour has no supermarkets or convenience stores in the country. And Chinese retailers' close relations with local governments will continue to help them get the good sites first when they expand.

Smaller formats also play to local retailers' ability to read local tastes, and finding the right merchandise mix is easier because the choice is more limited. Stores like Lianhua and Hualian have logistics systems that can deal with the scale.

"The main risk to the domestic players in food retailing sector is in the hypermarket sector because there is a greater variety of merchandise, and the logistics system has to focus on more kinds of goods," says Guo.

At the end of the day, it seems that China's food retailing sector is unlikely to be completely conquered by foreign invaders.

"Local retailers are learning every day," says Yeung. "Even with the opening of the market due to WTO, they still enjoy advantages such as local knowledge and administrative support from local government. My forecast is that both local and international retailers will co-exist and learn to live with one another."