Supermarkets are in many ways the forgotten workhorses of retail in China. Lacking the cheap and overwhelmingly fresh produce of wet markets, the huge floor areas and product ranges of hypermarkets like Wal-Mart and Carrefour, the low overheads of local shops and the long hours of convenience stores, they nevertheless account for almost 20% of the national retail industry.
Sales at supermarkets in China reached US$169.3 million in 2008, according to market research firm Euromonitor; and average annual sales growth of 7% is expected over the next few years.
But considering the low margins of the grocery business, which makes up the vast majority of supermarket sales, success for supermarkets in China is by no means a foregone conclusion. "The market is still quite fragmented," explained Alex Liu, an analyst with Euromonitor in Shanghai. "Maybe the leading 10 companies occupy no more than 10%."
That may be changing. In first-, second- and even lower-tier cities, companies are no longer finding easy opportunities for expansion. Consolidation and severe competition may see weaker stores culled as stronger players build on reliable supply chains and recognizable brands. However, there is no guarantee that even established local brands will prosper.
Shanghai-based Lianhua Supermarket Holdings (0980.HK) is confronting the challenges head-on. Last year, the firm formally completed a merger with Hualian Supermarkets, another brand owned by its parent, Brilliance Group, but which had been a competitor in markets around Shanghai and in eastern China.
Supermarket watchers say that while Lianhua will continue to operate Hualian stores under a two-brand strategy, the consolidation will bring benefits.
Citi analyst Sandy Chen, who has a "buy" rating on Lianhua’s stock, last year noted that the deal would effectively increase the company’s store network by 36%, while improving cost sharing and buying power. Hua Guoping, general manager of Lianhua, told CHINA ECONOMIC REVIEW that the merger process has been "very positive."
Nevertheless, risks remain. Julie Ke, a retail analyst with Guotai Jun’an Securities in Hong Kong, said the acquisition and restructuring of Hualian was a key factor in her awarding Lianhua no more than a "neutral" rating.
As China moves back into inflationary territory – the consumer price index rose 0.6% in November, the first indication of rising prices in 10 months – Lianhua sorely needs better cost sharing and buying power. Higher prices may help retailers in the short term as revenues increase, but sustained inflation raises operating costs, hurting bottom lines.
"[Lianhua’s] operating margin is below 1.5%. That’s quite low compared to international standards," said Ke. "We’re waiting to see if it can control its expenses better in the coming quarter."
The company also faces growing competition, with the arrival of foreign players. UK hypermarket operator Tesco entered the supermarket space in Shanghai in 2008, opening a new front in the retail wars.
"Even if we open a dozen new stores, [foreign brands] will still have more than us. Overall our market share is shrinking and theirs is growing," said Lianhua’s Hua. "As a local brand, we can develop quickly, but contending with the crazy expansion of foreign brands will be very difficult."
Tesco’s move into supermarkets aside, Ben Cavender, an analyst with China Market Research (CMR) in Shanghai, believes foreign brands will remain mostly concentrated in hypermarkets. Not only does this enable them to put their efficient sourcing capabilities and retail techniques to greatest use, it also means they can enter markets easily, opening a few large stores instead of many small ones.
Supermarkets will still need to meet the needs of their customers, who are growing more affluent and demanding higher quality products. Domestic supermarket chains like Lianhua and China Resources Vanguard (0291.HK) have established brands they can build up to attract consumers with the promise of quality goods and services. And now may be the ideal time to build, according to Liu at Euromonitor.
"Expansion costs during this period have been relatively low compared with boom times," he said. "It’s a hard time. There are challenges [for supermarket operators], but it will also provide some opportunities for them."