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Retail Outlook 2005
Battle lines are drawn as barriers fall
When it comes to China, 2005 is the year that foreign retailers have dreamt of. It is the year when the controls on the retail sector including distribution and franchising will be eased, allowing foreign retailers to expand and grow at will.
It is also the year when new retailers are expected to enter the market, drawn by its size and ease of entry. 2005 is also the year when the retail sector will witness some amount of consolidation, as some domestic retailers merge with the foreign entrants, while the smaller and less efficient retailers, foreign or domestic, may be gobbled up by the more efficient ones.
“On 11 December 2004, China waived geographical restriction on foreign retailers as per WTO (World Trade Organisation) commitment. As a result, foreign retailers would be able to enter provincial cities. Competition will intensify and more foreign retailers will enter the Chinese market,” says James Lee, vice-president of Corporate Affairs, Legal & Administration, Wal-Mart China.
Simply explained, since its accession to the WTO in 2001, China has opened up the retail sector in stages. In keeping with this phased liberalisation, it has thus far imposed several restrictions, including limits on location and prescribing foreign-capital requirements. Until now, entry of foreign retailers has been allowed only through the joint-venture route. There were also limitations such as prohibiting foreign retailers to hold controlling interest, if they chose to open more than three outlets in one location.
All this is about to change. Since December 11, foreign retailers have been allowed to go in alone in any location they choose, without restrictions on the number of outlets they open in a particular location. This change is expected to give impetus to the entry of new foreign retailers and freely allow the expansion of existing foreign retailers.
The foreign retailers will also have the freedom, at least in law, to distribute their products directly to the consumers, without having to go through traditional channels, such as local dealers.
Simultaneously, foreign retailers who already have a presence in the saturated triangle of Beijing, Shanghai and Guangzhou are expected to mount their onslaught on the Chinese hinterland (often referred to as Tier II cities), in their attempt to pre-empt the entry strategy of the new foreign competitors.
Meanwhile, domestic retailers are also expected to leverage their regional presence by expanding their reach to a national audience.
Interestingly, although none of the foreign mega-retailers are willing to speak on record on the issue, an indication of how the die is being cast comes from the manner in which many of the foreign retailers have already started mapping out the Chinese market.
Wal-Mart, the world’s biggest retail-chain operator, recently signed agreements with provincial governments to open supermarkets in Yuxi, a city in Yunnan Province, and Taiyuan, the capital of North China’s Shanxi Province. These agreements are part of the retailer’s plans to launch around 15 new stores in China this year, many of which would be in the Tier II cities.
However, Wal-Mart is not alone in its grandiose plans of conquering the Chinese hinterland. Germany’s Metro AG, which has generated sales of about RMB5.7 billion (US$692.2 million, 2003 figures), plans to increase its presence by 50%, up from the current 23 stores to about 35 outlets by end-2005.
Carrefour, which has a larger presence than most of the other foreign retailers, is planning to open 21 more ‘Champion’ discount stores to add to its 53 existing hypermarkets in the country. Tesco, which entered China in mid-2004 in partnership with Taiwanese retailer Ting Hsin, is attempting to extend Ting Hsin’s reach through its 30 hypermarkets so as to forge a strong local presence despite its late arrival.
The British retailer B&Q, which has opened chain stores in Beijing, Shanghai, Suzhou, Kunming, Shenzhen and Hangzhou, also plans to launch 10-15 shops a year in China this year. Wei Zhe, the company’s China region president, has been vocal about his strategy. He recently stated that his group was interested in choosing home retailers with very good location in key cities such as Beijing, Shanghai and Guangzhou because “location is one thing that cannot be regained”. He also maintains that his group is keen on expanding in central and western China, as B&Q plans to penetrate the eastern and southern Chinese markets.
Wal-Mart’s Lee summarises the emerging situation succinctly: “Competition will intensify and more foreign retailers will enter the Chinese market. There will also be some consolidation within the retail industry. We will see more merger and acquisition activities in the market. Some domestic retailers will merge with other retailers to enhance their competitive edge while others may be acquired by foreign retailers.”
A report released by China Chain Store & Franchise Association (CCFA) in 2004 reinforces Lee’s assessment. It showed that growth rate of China’s chain stores slowed down in the first half of last year due to the consolidation of retailers.
In 2001, when China opened its doors to foreign retailers as part of its WTO-accession agreement, the domestic retailers were convinced that being “small fish”, they would be swallowed by the big sharks of the western world. However, four years later, these fears have proved to be unfounded.
A study conducted by China’s Ministry of Commerce in mid-2004 threw up some startling facts. Contrary to expectations, foreign retailers were not at the top of the list of 30 top retailers evaluated by the ministry.
Instead, the Shanghai Bailian Group, comprising the merged entities of Shanghai Lianhua Group and Lianhua Group, the two biggest chain-store operators, topped the chart with RMB30.4 billion in sales in the first six months of the year, reflecting a 23% growth as compared to the previous year’s. This group opened over 432 outlets in 2004, increasing its presence to 4,789 outlets.
Beijing Gome, Suning Group, and Dalian Dashang (Group) Co Ltd followed the Bailian Group in ranking, while Carrefour, the world’s second largest retailer, ranked fifth. Besides Carrefour, only five foreign chain-store operators figured on the list. These included Suguo Supermarket Co Ltd (No.7), China Resources Vanguard Co Ltd (No.11), Wal-Mart China (No.17), and Jinjiang Metro (No.20).
The Chinese government, under immense pressure not to compromise local jobs and enterprises through its liberal approach to foreign-trade policy, is encouraged by such findings.
However, this situation could well change, beginning 2005, when total liberalisation of the retail sector is on the cards. According to China watchers, although Wal-Mart has until now been comparatively low key in China, it may intensify its expansion this year, possibly overtaking the other foreign retailers and challenging the hegemony of the domestic retailers.
Interestingly, experts say that while checks on foreign retailers is a major reason for their moderate prosperity, domestic retailers have also seen such immense growth on account of several reasons, including mergers, acquisitions and business consolidation.
Cultural affinity of the seller with the buyers has also been a strong force driving market dominance. The assimilation of local culture, accommodation of local sentiments and penetration of inaccessible markets through distribution systems tailor-made to fit local needs have helped the situation. Political clout, proximity to decision-makers and political support to domestic industry by the government have also played a significant role in carving out market share among the players until now.
The importance of local acceptance has not been lost on the foreign retailers. This is clear from the steps taken by some of them. Wal-Mart, for instance, recently chose to invest US$1 million to establish China’s first retail research centre at Beijing’s prestigious Tsinghua University. The move came just days after China’s trade union authority threatened to blacklist the US retailer for refusing to establish union branches.
Although Lee Scott, president and CEO of Wal-Mart Stores Inc, did not touch upon the union issue, he did take the opportunity to reassure everyone in his address that his company would continue to seek Chinese partners and enhance cooperation “as it always did”, even after the lifting of restrictions. He also maintained that the competition in China for Wal-Mart would come from local rather than foreign retailers.
The Metro group has also come up with its own strategy to strengthen local acceptance. It announced its decision to endow a professorship to the Chinese-German School for Postgraduate Studies (CDHK) at the Tongji University in Shanghai.
Simultaneously, it announced the opening up of a training centre in Shanghai, joining the other three global centres in Düsseldorf, Paris and Moscow. According to the company, the House of Training links a diversity of regions, as well as the mature and developing countries. Thomas Hübner, CEO, Metro Cash & Carry International, explaining the company’s policy, says: “The experts within Metro Cash & Carry know best what is important for our company because they have the permanent contact to our customers.”
A highlight of this project is the demonstration kitchen on the campus, which will be used to elevate local skills to international levels. “This kitchen will serve as a valuable bridge between suppliers, customers and Metro Cash & Carry employees in China,” said Jean-Luc Tuzes, president of Metro Cash & Carry China.
For number crunchers who prefer to base their projections only on statistics, 2005 is likely to be more than a promising year for the retail sector. The economic growth is expected to decelerate to about 8%-8.5% annually, in keeping with the Chinese government’s decision to cool down its overheated sectors, such as cement, steel and real estate.
Year-end projections from China’s Ministry of Commerce show that the Middle Kingdom would end up with retail sales growth of 13% in 2004 as compared to the previous year’s. In actual figures, retail sales would touch RMB5.2 trillion at end-2004. After adjusting for inflation, retail sales would be up 9.8% as compared to 2003.
Further, in 2005, the overall retail sales growth would average 10%, driven by strong consumer spending, especially in cars, housing and telecommunications products. In 2004, over 20 new foreign-funded retail businesses were approved and this robust growth may continue in 2005.
As at press time, the figures available showed that the sales of China’s 30 largest chain operators surged by 38% during the first half of 2004, far outpacing the 12.8% growth rate of China’s total retail sales during the full year. Retail telecommunications sales surged by 42.8% year-on-year in the January-October period. The catering industry sales witnessed a 22.3% growth in the first 10 months, touching RMB596.7 billion.
According to the disaggregates provided by the China General Chamber of Commerce (CGCC), for January-August 2004, the general retail volume of consumer goods was RMB2,988 billion, increasing by 12.9% compared with the same period last year. The urban retail volume was RMB2,243.5 billion, reflecting a 14.6% growth, while the county and sub-county retail volume was RMB11,283.6 billion, showing an increase of 8.7% over the previous period. The volume generated by the retail and wholesale industry was RMB2,813 billion, up by 11.8%, while the volume generated by the catering industry was RMB456.1 billion, up by 23.4%.
As the focus of the Chinese government has been to cool down the economy in select sectors without affecting growth in others, data-crunchers have also been looking at the consumption figures to draw their conclusions. These show that disposable income of urban and rural residents grew by 7% and 6% respectively in the first 10 months of 2004. Also, nine million new jobs were created during this period, reflecting the outline of things to come.
According to He Jihai, chairman and president of CGCC and chairman of Federation of Asian Retailers Association (FARA), it has been 12 years since Shanghai Yaohan Company was approved as the first Sino-foreign joint-venture retailer in 1992.
“The entry of foreign retailers brought in to Chinese domestic retailers new business formats, the most advanced management experience, retail technology, marketing techniques and service concepts; they also brought with them the pressure of competition, which stimulated the development of domestic retailers and promote the progress of China’s retail industry.
“Their entry played a positive and important role in the rapid modernisation of China’s circulation,” he says.