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China's
retail market: Distribution the key
By Jayanthi Iyengar
US sales companies have been celebrating and the US-China Joint Commission
on Commerce and Trade has been pointing to eight recent business-friendly
agreements, one of which provides for the opening of China's retail sales
distribution system to foreign competition, leveling the playing field.
Under this agreement US companies will be able to distribute their products
directly to Chinese stores without having to go through a state-owned
distribution company. It goes into effect on January 1, 2005.
The agreements are the result of China's accession to the World Trade
Organization (WTO), and Beijing is required to drop preferential treatment
for any company and remove barriers to foreign companies so that they can
compete equally. Despite the rapid growth of the economy after economic
reform, the Chinese market is still not mature, yet its very immaturity
opens possibilities and leaves wide room for maneuvering and
self-definition.
"This is a landmark day and a very fruitful day in terms of the developing
relationship between the United States and China," said US Commerce
Secretary Don Evans, who signed the agreements and led the team that
included Trade Representative Robert Zoellick and Agriculture Secretary Ann
Veneman.
Bill Primosch, director of international policy for the National Association
of Manufacturers, however, sounded a more cautious note. "We'll need careful
monitoring to ensure the Chinese deliver on what they've promised," he said
soon after the agreements were signed last Friday.
As many companies have found to their peril, doing business in the Middle
Kingdom is as much about what they do and how they do it as it is about what
the Chinese government does. After having sunk in millions of yuan, many
companies have discovered the great truth about the Chinese market, says
Piset Wattanavitukul, China-based business management expert, former
academician and columnist with the Asia Pacific Management Forum. That is:
"There are many distinctive worlds in one China." And the astute and
successful seller gets to understand them, how they work or don't work
together, and works the system that covers an enormous land mass. China also
defies some of the conventional marketing wisdom: the new market bonanza may
not be in the cities, but in the developing rural areas.
An often-cited example is that of the Thai energy-drink manufacturer Red
Bull. When the company entered the Chinese market in early 1996, with
advertising budgets exceeding 100 million yuan (US$12 million), it assumed
the market would be its for the taking. Yet things didn't quite pan out that
way. Instead of reaping the benefits of its blitzkrieg, it found to
its dismay that its competitors and "me too" brands were the beneficiaries.
Distributors must cover huge distances
According to Wattanavitukul, Red Bull's failure lay in not understanding the
challenges of covering a 9.6-million-square-kilometer market in a short
time. The company located its manufacturing base in the Chinese city of
Shenzhen and the island province of Hainan - both special economic zones
that give incentives to foreign investors, and both in the south. Its
markets, however, were in the north and northeast. Consumers were drawn to
the retail outlets by the company's advertising, but when the product was
not available, they ended up buying the competitors' and imitation products.
Latter-day entrants such as Pepsi understood the value of setting up their
own marketing teams in order to directly work with their retailers, but
experts say there is no such thing as a set formula when it comes to
cracking the Chinese market. One reason is the very nature of the market -
huge and fragmented. Another reason is the legislative, social and political
framework, which is constantly in flux. For instance, foreign suppliers were
initially allowed to sell directly in China. This led to the growth of
multi-layered marketing. But that approach was abandoned after questionable
behavior by foreign firms, and regulations in 1999 made it necessary for
foreigner suppliers to use the state-owned distribution system.
Even today, the mail-order business is unknown in China, but the Internet,
particularly after the outbreak of severe acute respiratory syndrome (SARS),
is being seen as a viable alternative channel for direct sales. As marketing
expert Alice Chung notes in an article on about.com, "it is not the product,
but getting the product to reach their customers" that is critical to
success in China. Chung has said that recent liberalization of the
distribution system, to comply with WTO requirements, intensifies both
opportunities and competition. Firms that establish effective distribution
networks will get a head-start in this fast-growing market.
Any company doing business in China today must understand the nature of the
Chinese market, consumerism, distribution network and habits. At a very
general level, the Chinese market could prove to be a bonanza. This base is
constantly growing, but cracking this market is another matter.
In spite of the high density of population and progressively higher average
annual incomes, per capita car ownership is still low in China as compared
with the developed markets. Further, the Chinese prefer foods to processed,
packaged products, and they still continue to be touch-and-feel shoppers.
This makes them shop daily, unlike their Western counterparts. For
retailers, these habits mean setting up their sales outlet in the city
centers. Rents there are high, pushing up the cost of retailing.
The cash-and-carry-format retailers such as Metro AG and Wal-Mart have been
able to create a following, despite outlets in the suburbs. The big outlets
are generally the hypermarkets. These hypermarkets are all-in-one stores,
which sell a combination of foodstuffs and consumer durables. The large
retailers are able to draw customers to their suburban units with this
format because of their lower unit prices, made possible by volume sales.
The number of customers tend to offset the price advantage against the cost
and effort of traveling to the suburbs, but it is another matter when it
comes to the smaller retailers, who cannot extend similar benefits.
The market cream is in virgin rural territory
The buying segment is concentrated in urban China. A supplier may be tempted
to concentrate on this market, but those who have been doing business for
long know that the cream is concentrated in virgin rural territory. These
markets are far apart, disparate and difficult to penetrate, but they
represent significant market share and could make the difference between the
success and failure of an enterprise.
With consumerism, the urban Chinese have become discerning. They are no
longer blindly swayed by foreign brands. They ask specific questions. They
also seek local brands, driven by the nationalistic pride to buy local
products. The quality of the local products itself is improving, and these
also may carry a cost advantage because of the lower labor costs and
location. Further, relationship between buyer and seller is another
important parameter that determines sales. A foreign supplier would have to
contend with this factor and overcome local preference when doing business
in China.
It is for these reasons that Jason Yang, manager of consultancy and research
for Colliers International in Beijing, recommends retaining an experienced
consultant before venturing into China. This expert would be able to help a
new entrant run a market study to assess consumer behavior and the past
performance of other failed and successful retailers. He or she would
provide guidance on major shopping areas, rental levels, target groups,
revenue stream, market positioning and financial analysis. Further help
could be provided in site selection and location, taking into consideration
legal issues such as building height, zoning and consumer profiles.
While these are important issues at the retail level, distribution is yet
another ball game when it comes to China.
At present, foreign firms are restricted from distributing imported products
and from managing distribution networks, wholesaling outlets and warehouses.
These restrictions are in place to protect the domestic distribution
industry, which either has its origin in the state-owned distribution
centers or is part of the private distribution companies set up after China
permitted private enterprise in this area.
The existing distribution system has grown from the traditional state-owned
distribution system and suffers from all its ills. The state-level
distributors send a product to the provincial units, which in turn sell to
the retailers. In the rural areas, where a larger geographical area has to
be covered, the layers increase. This makes distribution easier and coverage
of the retail territory possible - distributors pool and distribute several
products to cover larger territories. However, from the suppliers' point of
view, every layer represents additional cost in the form of a 5-7 percent
dealer commission. In the ultimate analysis, these have to be passed on the
consumer, which could lead to the out-pricing of a product as compared to
that of a competitor who might be a domestic manufacturers competing in
local instead of national markets.
Foreign suppliers try to work around the restrictions and attempt to reduce
the number of intermediaries by either directly contacting retailers and
working with them or by working through Hong Kong agents. Another equally
viable alternative is to set up a joint venture with local wholesale and
retail partners, though the quality of Chinese salesmanship and the nature
of the market ultimately demand the direct involvement of the supplier in
promotion and sales at the retail unit.
"So important has it become to control the point of sales in China," says
Wattanavitukul, "that suppliers often send their own sales personnel to
promote their product in the retailer's outlet."
Jayanthi Iyengar is a senior business journalist from India
who writes on a range of subjects for publications in Asia,
Britain and the United States. She may be
contacted at
jayanthiiyengar1@hotmail.com.
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