Multinationals have grasped opportunities for expansion in China’s retail sector, particularly since restrictions on operations were eased as part of the country’s WTO accession requirements. China is the focus of many global development strategies, but competition in the modern marketplaces of first-tier cities Beijing, Guangzhou and Shanghai is becoming increasingly cutthroat.
"There are one or two cities, like Shanghai, that in some retail sectors are becoming close to saturated, so companies need to go elsewhere," said Paul McKenzie, head of regional consumer research at CLSA.
The retailers’ search is taking them well beyond the super-cities of Beijing, Shanghai and Guangzhou, and the provincial capitals and eastern seaboard hotspots that occupy tier two. A prototypical third-tier target is an upwardly mobile prefecture-level city, relatively undeveloped but showing signs of increasing affluence among the population.
"I think basically people are going into third-tier cities largely because there really is less competition," said Vineet Sharma, consumer sector head at JP Morgan.
Wal-Mart is hoping to emulate its fantastic success in the United States by launching a major expansion drive this year, with about 20 new stores due to open. But these will not only be in the metropolises and provincial capitals – the world’s biggest retailer also plans to set out its stall in third-tier cities.
In December last year, Wal-Mart opened its 55th store in China in Wuhu, Anhui province, a city with a population of around 2.2 million. Number 56 soon followed in 5 million-strong Yueyang in Hunan province. Both cities are located in the fast-growing Yangtze River Delta region and clearly Wal-Mart is hoping to ride the consumer wave generated by such regions. Over the next five years, the company plans to hire 150,000 new employees, which would quintuple its current Chinese workforce.
Looking to enlarge
"Wal-Mart is on an accelerated expansion program," said McKenzie of CLSA, adding that it is only since constraints on overseas retailers were lifted in 2004 that the American giant has been aggressively tackling the Chinese market. "Wal-Mart chose to play by the rules," he said. "Carrefour flaunted the regulations and went ahead and opened stores without getting central government approval ? they got away with it."
Introducing hypermarkets stuffed with foreign-branded products overnight clearly does not take into account local conditions. The most successful retailers have offered multiple formats and diverse product lines, with Carrefour being the epitome of this flexibility. China’s leading hypermarket chain has opened supermarkets and hard discount stores to link up its product sourcing network and adapt to the situation on the ground. The French firm also plans to open about 20 new stores in China this year.
But the hypermarket format is unlikely to be as successful in smaller cities, where car ownership is low, local stores are popular and the habit of buying fresh produce daily is deeply ingrained.
"The reason for going to other areas is to be the first to lock in loyalty," said Joe Mueller, Accenture’s retail senior executive for Greater China. "The great retailers are the ones that balance growth for today and growth for the future."
Mueller suggests retailers are involved in a mad dash to secure first-mover advantage – the key factor after price, in his opinion. "If they are the first they can build up brand loyalty," he said. "China is a very diverse place. Understanding what customers desire in different areas – that usually takes time."
Multinational retailers will have to weigh up opportunities on a case-by-case basis, as that is the only way to approach divergence in this vast country. There are huge disparities in wealth across the nation, meaning much lower per capita income and less consumption power in the central, southwestern and western regions. In terms of sportswear branding, for example, it is obvious that such major players as Adidas and Nike enjoy huge success in the large metropolises, while Chinese brand Li Ning is very strong in smaller cities.
Location the key
"The most important criterion will simply be the location of the stores," said CLSA’s McKenzie. "The best-located will tend to get the best traffic. It is quite important to get in early to lock up the best sites ? pricing and branding is actually of secondary importance to the location of the stores."
The Ministry of Commerce has delegated annual inspections of overseas retailers to lower-level governments. Logistical obstacles aside, local governments in underdeveloped regions are less familiar with international deals, and more prone to protectionism. Though rent and labor are cheap – particularly for the first mover – managerial talent can be hard to find.
Of course, local governments’ commercial development plans can benefit rather than hinder multinational retailers, including supermarket chains. Wholly owned status may not be the right approach, though joint ventures or dabbling in mergers and acquisitions could be a way in. Working with domestic partners means retaining local expertise, and a chance to tackle the local chain stores that are much stronger in smaller cities.
Tesco bought 50% of the shares in Hymall from Ting Hsin Group of Taiwan in July 2004, acquiring an immediate mainland presence. The British retailer is adding to its 39 stores at a rate of 10-15 a year, but these will be in coastal areas, not undeveloped third-tier cities. "We never say never, but we are quite new in China," said UK-based Tesco spokesman Greg Sage. "We want to grow businesses of scale."
While multinationals are rushing to open new stores in medium-sized cities, they are still tending to be clustered in the comparatively affluent Pearl and Yangtze River Delta areas, where the emerging middle class can already afford to shop ’til they drop. Opening outlets in third-tier cities where infrastructure is poor and supply chains are inefficient due to poor transport networks, and the simple fact that they are much farther from the sea, is a more challenging option.
For JP Morgan’s Sharma, it is a case of comparing GDP per capita figures in different areas and identifying "an affordable deal". In third-tier cities "there is lower revenue per square meter", he said. "You have to balance lower costs and lower revenue. You try to go to places where you can sell more. That’s really it – income level."
It seems likely that multinationals will on the whole choose to consolidate their positions in medium-sized cities in the better-off coastal areas, with five or six stores in each province compared to one or two – including the provincial capital – in the central and western regions. A large bet on western China effectively involves a bet on the country’s ability to better spread its wealth – and few foreign retailers seem ready to gamble.