Retail sales have remained strong in China compared to much of the world. Nonetheless, local retailers are all looking for ways to meet customers’ needs for higher value at lower prices. Apparel maker Esprit’s general manager in China, Steve Shen, has been with the firm since its first days on the mainland. He spoke to CHINA ECONOMIC REVIEW about the evolution of the Chinese retail market and how subtle changes to Esprit’s business model are helping it through the downturn.
Q: Can you explain Esprit’s mix of branded stores and franchise stores in China?
A: We have about 300 retail stores in our "direct managing cities"of Shanghai, Beijing, Guangzhou, Dalian, Chengdu and Chongqing. We also have another 550 franchise stores or counters in another 110 cities all over China, giving us almost full coverage in the first and second tiers and a strong presence in the third tier. In the beginning we established Shanghai and Beijing as our direct managing cities and decided to expand quickly through franchising. Money was never the problem with our expansion; it was that the rules of the game are different in every city. Our franchisees are local people who have local knowledge, so we thought this was the best way to expand. As the business grew, we found that Dalian, Guangzhou, Chongqing and Chengdu were becoming important cities, so we bought back our franchise stores there and made them direct managing cities.
Q: Does franchising pose any risks to the brand image if the franchisee doesn’t manage the store well?
A: If you think of your franchises as second-class stores, and you sell them leftovers at a higher wholesale price, then they’ll never make money and they’ll be poorly operated. But if you think of all these franchise stores as Esprit stores, and treat them as your own colleagues, I think you will find these franchisees to be of great assistance in China. This business model has proven successful because 70% of my franchisees make money.
Q: What other ways have you had to adjust your business model for the China market?
A: In Europe maybe half of our revenue is from wholesale. But from the very beginning we were given the flexibility to pursue direct managing and franchising in China. It has proven to be very successful. As the legal environment in China is improving even in second- and third-tier cities, we will strengthen our direct managing model.
Q: What challenges does China’s legal environment pose to your business?
A: If you do business in China you face two governments, central and local. Local governments want you to contribute a lot to their economies, not only by creating jobs but also through taxes. As a global, listed company we usually hope we have one legal entity, say in Shanghai or Beijing, and then set up branches. But this can be very difficult in China. You need to set up a lot of different local legal entities and pay local taxes to survive. As tax regulation improves, you will see a lot of local governments allowing firms to open branches without establishing independent legal entities. This will be a big improvement for us.
Q: How have sales in China been affected by the global economic crisis?
A: We have been affected negatively by the global economic crisis, but we hope to maintain growth of around 10% this year and next year. This is lower than the 30% annual growth seen in the past five years.
Q: Are the days of 30% growth gone forever or could we see a rebound?
A: I think we can get back there in China, but it won’t be easy. If we want to return to 30% we should restructure our business and improve our supply chain, because consumers now want more value. For example, department stores that do not have discounts are seeing sales drop by 20-30%. Those that are maintaining single-digit growth are doing so because of promotions. Only one sales channel is growing very quickly: outlets. Esprit probably has one of the best turnovers of any company in that segment right now.
Q: Have you scaled back your expansion plans for this year?
A: We still plan to open more stores, but we won’t open stores for fixed rental prices. Instead we will share the risk and benefit with the landlords, which is common in China.
Q: You new store in Beijing’s Sanlitun village must have been rented for a fixed price. How is it performing?
A: We rented that store at the peak time before the Olympics so we couldn’t talk to them about sharing the risk. The store is doing well, but it can’t make money at this time. However, this was already factored into our budget. I knew the real estate market was hot, but it was important for Esprit to be visible in Beijing. We think of it as an advertising cost. For a brand like Esprit, the best advertising is the store itself.
Q: How have consumers changed and how have you repositioned your brand in response to this?
A: When we began in China, we decided to position ourselves at the higher-end. Actually our prices in China were higher than they were in Hong Kong because of import duties and because we didn’t have economies of scale. We were targeting the small proportion of the population that wasn’t price sensitive and this strategy gave us our first five successful years in China. Now Chinese consumers are more open to the world and international brands can easily enter the market. So we brought our brand position in China in line with our global position, targeting the mid-range consumer segments.
Q: How do you differentiate yourself from your competitors?
A: The market for apparel in China is huge and no brand has a market share of more than 1%. So there’s no face-to-face competition among brands. If Zara opens a store on the same street as us, our revenues grow by 20-30%, because more consumers are coming to the street. One area where there is competition is over land. There’s a lack of premium retail space in China, so we’re always competing for the best locations.
Q: What will be the key challenges for Esprit China in the next two years?
A: Given the poor economic data overseas, I worry that the brand’s main support team will be withdrawn back to Esprit’s core market of Germany. This would mean that China gets less attention. The most important thing is to improve supply chain efficiency so you can provide the same quality at a low cost. That’s how you win in a deflationary environment, because the consumer always wants to pay less and get more.