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SPOTLIGHT ON ASIA - CHINA by Jay Smith for TOTAL LICENSING MAGAZINE -- SUMMER 2004 They say that history repeats itself. If that old maxim is true, then the economic phenomenon occurring in 21st century China should come as a surprise to no one. In modern industrial history, we have seen one country after another transform from a producing economy to a consuming economy. In the mid- to late-1800’s, England was the industrial powerhouse of the world. In the early- to mid- 1900’s it was America. After World War II Japan took over the job, followed by Taiwan and Korea. All of these nations became wealthy consumer economies and transferred most of their industrial production off-shore. Now China is the world’s factory. What effect will that have on their economy? It is already starting to show. In the last quarter of 2003, the Chinese economy grew at an incredible 9.9 percent rate. That was nearly repeated in the first quarter of 2004 with growth of 9.5% Industrial production increased by nearly 18 percent and imports increase 42 percent. Disposable income rose by 9.3% last year in China’s urban areas. Some Western economists believe that China is actually understating these figures so as not to give the appearance of a bubble economy developing. It is clear, however, that a good portion of the world’s wealth is being reallocated to the People’s Republic of China. Another economic maxim we know is that as consumers become wealthier, they demand a wider selection of brands in any given category of goods. Consumption shifts from the purchase of necessary goods, to an expression of individual identity. There is certainly plenty of pent up demand for personal expression in China. This is a country where, barely 25 years ago, the standard dress was a government issued “Mao suit.” Along with the move toward a more capitalist economy, the government has also allowed far more Western influence to enter the Chinese culture than could have even been imagined a generation ago. Today, virtually every major luxury brand is available in the department stores and boutiques of Shanghai and Beijing. However, that is not the big story. Every major city has boutiques to serve the privileged few. The real story is the emerging middle class in China, which the Chinese Academy of Social Sciences estimates at 250 million consumers and growing rapidly. They predict it will grow to over half a billion people by 2020. By Western measures, its probably half their estimate. However it is easy to see that China will be the world’s largest consumer economy in the very near future. This group of middle class Chinese consumers is demanding top quality consumer products with recognizable brand names at reasonable prices. The trouble is, there aren’t enough brands that fit this requirement. With high import tariffs still in place, even moderately priced foreign brands are out of the reach of much of the middle class. Chinese manufacturers, long reliant on serving export markets on an OEM basis, have not developed the creative marketing capabilities of brand building. So where will all the brands come from? One answer is Brand Licensing. Until a few years ago, the licensing business was virtually non-existent in China other than the production of licensed character toys for export shipment. That is changing, however. Between 1998 and 2001, retail sales of licensed products grew to $600 million from $440 million. While the growth is substantial, the total volume represents only 0.6% of the world’s sales of licensed products. On a per capita basis, Chinese consumers buy only $0.40 of licensed products annually versus $91.70 in Japan, and $235.00 in the USA. Despite the rapid growth and seemingly endless potential, licensing is not as easy as it might appear at first glance to an outsider. As a business model, licensing also is a still a very new concept for Chinese companies. While they may know about it from the penetration of character-based products from Disney and others, the idea of licensing a fashion brand, for example, is still very novel. As a result, a trip to Shanghai Department Store No. 1 can be a lesson in Chinese brand creation. With a certain homage European fashion brands, you will find Cianni Versace, Geoge Amoni, Pual Cardon, Louit Witton, and at least 20 variations of Valentino. One reason for this may be the Chinese attitude toward ownership. It is simply part of their culture to own, not lease, assets. Since a licensing contract is essentially a short term lease, there is some natural resistance to it, There is a substantial amount of fear that once all the hard work of launching the brand is done, the brand owner will take back its prized asset, set up its own operation and leave the Chinese licensee holding an empty shopping bag. The Chinese are also notoriously hard negotiators with incredible patience. They know that the world of brands is beating a path to their door wanting access to the world’s largest consumer market. The smart licensees now ask for low or no minimum guaranteed royalties, royalty-free periods, advertising allowances, and design support. As a result, many licensors feel that they are entering a joint venture agreement rather than a brand license. A third limiting factor on the licensing potential in China is concern over intellectual property rights (IPR) and counterfeiting. Both licensors and licensees fear the cost of success – rampant piracy. This does continue to be a serious problem in China, and it ranges from blatant design and trademark infringement, to the sort of brand homage mentioned above. The good news is that a number of forces are moving attitudes, laws, and law enforcement in the right direction. China’s entry into the WTO certainly puts new pressure on the Chinese government to tighten IPR laws and enforcement. We have already seen new laws being enacted and more public displays of their enforcement. In a country as directed by the central government as China is, it doesn’t take long for word to get around when the government is serious about something. Another motivating factor is the increasing value of Chinese brands, particularly in the mobile phone and house wares segments, and the desire of the Chinese to protect the IPR of their own companies. Certainly one of the most valuable and prestigious brands in China now is Beijing 2008, the Olympic brand. Many companies will be introduced to the concept of licensing for the first time via their desire to be involved in Olympic merchandising. If they choose to officially license the Beijing 2008 brand, they will naturally become aware of the cost of counterfeiting to the value of their own investment. The Chinese government will most certainly afford the Beijing 2008 brand some of the tightest control of IPR that China has ever seen. This will go a long way toward educating both manufacturers and consumers as to the importance of trademark and other intellectual property rights in a modern economy. Despite some of the challenges of licensing in China, the raw size of the market makes it an attractive territory for international brands to pursue. In order to capitalize on that potential however, licensors must take a flexible approach. They must temper their expectations of quick profits and build partnerships for the long term. The size of the market does not mean that the licensor can demand huge minimum royalty guarantees right off the bat. The Chinese distribution and retailing infrastructure is still underdeveloped and fragmented. It takes time to develop a business outside of the large cities of Guangzhou, Shanghai and Beijing. Also, the average wage, even of those considered to be middle class, is substantially lower than in Western countries. Products need to retail for lower prices to account for this, so royalty rates should be a bit lower than in the West. In order to overcome the resistance to “renting” a brand name, contract terms should be longer than the standard three to five years that most licensors are accustomed to. Success in Europe or the USA does not guarantee that Chinese consumers have heard of your brand, or that they will identify with your brand. Licensors should note that even the strongest brand names may have a difficult time in China if they are only offering the use of their name. Chinese licensees expect a good deal of support from the licensor. This is especially true among Chinese companies who have been OEM manufacturers. They are used to following exact instructions from their customers and often don’t even employ designers or marketing staff. The attractive brands to license are those that provide the licensee with a full package of design support, marketing materials, and merchandising advice. In a sense, they are looking for something closer to a franchising system with a complete manual on how to run the business. In order to find the road to success in Mainland China, most Western licensors would be well-advised to work through an intermediary that is familiar with the Chinese market and its particular ways of doing business. A licensing agent based in Hong Kong or China can be an invaluable bridge between a licensor and potential licensees in the Mainland. That is true not only for finding partners and negotiating licensing agreements, but also for managing the licensees over the course of the contract. Communication across many time zones is difficult enough. Communication in a foreign language to a very different culture can lead to misunderstandings and missed opportunities. A licensing agent based in the region can help facilitate the sometimes difficult and tedious product approval process. An agent can also assist in verification of royalty reports and collection of royalties, in monitoring activities of counterfeiters, and in coordinating brand promotions between various licensees. A good starting point for licensors would be Hong Kong. With a bi-lingual business community, strong connections to China, and well-developed infrastructure, Hong Kong has long been the chosen intermediary for doing business in the Mainland. The Hong Kong Trade Development Council (TDC) is very active in promoting licensing, and in promoting Hong Kong’s role as a facilitator in doing business with the Mainland. The TDC sponsors Asia’s largest licensing fair in Hong Kong in July each year. Licensors and agents display their brands and welcome guests from around Asia. The TDC also sponsors a seminar program which is instrumental in educating Chinese companies on the “how to-s” of brand licensing. The TDC’s business matching service can assist licensors in finding an appropriate licensing agent or licensee. Hong Kong is not only a place to find licensing support, however. Hong Kong itself is the fifth largest market for licensed products in Asia, recording US$120 million in retail sales in 2001. Beyond that, many Hong Kong companies are large players in the Mainland Chinese market. Currently 60% of licensees in China are foreign-funded, largely by companies based in Hong Kong or Taiwan. Appointing a Hong Kong company as licensee for China has many advantages. If the licensing contract is written in Hong Kong, based on Hong Kong law, many foreign companies feel they can expect a more fair hearing in the case of disputes. Hong Kong companies are also more sophisticated in brand development and more conscious of IPR issues. With the implementation of the Closer Economic Partnership Agreement (CEPA) agreement between Hong Kong and China, Hong Kong companies will be able to distribute their products tariff-free in the Mainland from this year. Likewise, Hong Kong is opening its borders to more and more Mainland tourists. This will increase the sales of licensed products in Hong Kong. More importantly, it will increase the exposure of brands to Chinese consumers. While the Chinese government has slowly allowed the penetration of Western media into the country, much of the cultural influence in China comes from Hong Kong. Consumers watch Hong Kong television, read Hong Kong magazines, and see products and brands in Hong Kong shopping centers when they visit the country. In some sense, Hong Kong is the showcase for brands wanting to enter the Chinese market. There is not much doubt that China’s consumer market will be the world’s largest in the next 10-15 years. That translates to tremendous potential for licensing Western brands. However, the licensors that are best able to take advantage of this potential will be those who are able to adapt their thinking to the realities of the Chinese market and to the Chinese ways of doing business. |
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