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Chinas retail markets are evolving more quickly than companies anticipate
Wing-Kwong Chan, Javier Perez, Anthony Perkins, and Miranda Shu

ost investors acknowledge Chinas potential as an important retail market in the twenty-rst century. Yet few have been prepared to invest there, deterred by their belief that it is still a market for only the most basic consumer goods. They are also intimidated by restrictive regulations, chaotic distribution, and fragmented retail channels. They would do well to reconsider, for although the market presents diculties, it is evolving faster than most people realize and already ofers a broad range of opportunities with attractive returns. With 40 cities open to foreign investment and many more ready to join them, the time is right to stake a claim. And as with other investment opportunities in China, rst movers are likely to garner the richest rewards. Market scope The value of Chinas retail market rose from $170 billion in 1991 to $250 billion in 1995 a compound annual growth rate of 11 percent. The country is already Asias largest retail market outside Japan, and is set for yet more explosive growth. With gross domestic product projected to expand by 10 percent a year, by 2005 China will have 230 million middle-income consumers earning more than $1,000 a year and a retail market potentially worth more than $900 billion (Exhibit 1).
Exhibit 1

Growth of the retail market in China, 19952005

$ billion, 1995 CAGR = 14%

1995 2000 2005

250 ~500 930

Source: International Marketing Data and Statistics, 1996; China Statistical Yearbook, 1996; McKinsey analysis

Wing Chan is a consultant and Javier Perez is a principal in McKinseys Hong Kong office; Tony Perkins is a principal in the Beijing office; and Miranda Shu is a consultant in the Shanghai office. Copyright 1997 McKinsey & Company. All rights reserved.

In some regions, pockets of real auence are emerging that will lead to double-digit expansion in retail spending. Within the next decade, the regional market of Shanghai and the adjacent province of Jiangsu alone will compare in size with the retail market for the whole of Thailand (Exhibit 2). These pockets of auence will boost demand for clothing, consumer durables such as home appliances and furnishings, personal care products, and other household goods. As the economy expands, the weight of retail spending is shiting toward these items, as it has done in Thailand and Taiwan. More auent, urban citizens already

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Exhibit 2

Retail markets of Shanghai and Jiangsu compared with Thailand, 19952005

Population
Million Shanghai and Jiangsu Thailand

1995 60 2005 72 GDP

$ billion

84 93
CAGR = 1% CAGR = 2%

1995 Jiangsu 2005 Retail sales Shanghai

$ billion

90 160 ~230 ~350

CAGR = 10% CAGR = 8%

1995 2005

30 40 ~110 ~120
CAGR = 14% CAGR = 11%

Source: Jiangsu Statistical Yearbook, 1996; Shanghai Statistical Yearbook, 1995; Euromonitor; EIU; McKinsey analysis

purchase a disproportionate share of them: consumers in the 100 biggest cities allocate more than 40 percent of their spending to such goods, compared with about 23 percent among rural consumers. Given projected growth in income in those cities, non-food expenditure could rise by 18 percent a year, accounting for almost 60 percent of retail spending and creating a non-food market worth $230 billion by 2005 (Exhibit 3).
Exhibit 3

Growth of non-food retail sales, 19952005

Future retail sales of top 100 cities
$ billion, percent

41 1995 51 2000

59 $105 49 $242 59 41 ~$390 Food

2005 Durables, clothing, and other household goods

Source: China Statistical Yearbook, 1996; Taiwan Monthly Statistics of Finance; City Statistics Yearbook, 1995; McKinsey analysis

Spending on food will also grow, albeit more slowly. The 100 biggest cities will consume $160 billion-worth of food by 2005, compared with todays level of $60 billion. The type of food urban Chinese consume will change, with higher-quality processed foods such as branded soy sauce and frozen dumplings accounting for a larger share of expenditure. Discretionary spending on snacks and fast food will rise rapidly.

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Market opportunities Although Chinas market is likely to remain dominated by Mom and Pop shops of which there are more than 9 million with average annual sales of $20,000 there is plenty of scope for modern retail formats. Distinct consumer segments are already emerging as a result of the wide availability of consumer goods, massive increases in advertising, and steady exposure to new retail outlets. Auent women in Shanghai want branded cosmetics and fashions from upmarket stores such as Yaohans Pudong district store, for example, while middle-income families in a densely populated suburb of the city are attracted to the French store Carrefour by its low prices and superior selection. Older, traditional shoppers in Beijing can now meet their basic needs in pleasant, air-conditioned department stores that ofer somewhere to park their bicycles and a chance to try Western fast food. In the city of Wuhan, younger, less auent shoppers who are starved of choice and lack clear preferences seek variety and explore low-priced branded products. Rich consumers in Shenzhen, meanwhile, marvel at their new Wal-Mart, which ofers a choice hitherto available only to those able to make an occasional trip to Hong Kong.

Department stores
The department store is a well-established and popular format in China, introduced during the era of central planning to serve as the main point of distribution for manufactured consumer goods. The country has about 7,000 of them with sales of more than $1 million a year, accounting for approximately 35 percent of sales of durables and clothing. Despite being chaotic, these stores command customers loyalty and are perceived as convenient, one-stop shops that ensure a degree of quality. Even comparatively sophisticated consumers in Beijing, Shanghai, and Guangzhou the three biggest cities still rely on department stores for a large portion of their important shopping and visit them frequently. Before the choice of entertainment widened, they served as a popular destination for family weekend outings, a tradition that persists. The market remains fragmented, however, and not uniformly served. Chinas top 200 local retailers, spread across the 100 largest cities, account for only 9 percent of total non-food retail expenditure and for 32 percent of department store sales nationwide. And, compared with other Asian countries, department stores market penetration is low. They account for only 16 to 40 square meters of space per $1 million of total retail spending and for only 6 to 30 square meters of space per 1,000 people (Exhibit 4).

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Exhibit 4

Market penetration of large department stores,* 1994

Square meters per 1,000 population Square meters per $1 million of retail spending 109 Taipei 110 140

45 40 30 23 18 16

Hong Kong Shanghai Beijing Chengdu Hangzhou Guangzhou 6

30 23 13 8

* Stores with revenue over $30 million Source: All China Database; China Statistical Yearbook, 1995; literature search; Sales and Distribution Industry in Taiwan; Hong Kong Statistical Yearbook, 1995; McKinsey analysis

Given all this, it is safe to assume that upgraded department stores ofering a full range of quality goods and professional service in a modern environment will be successful. Indeed, our analysis shows such stores can achieve return on capital employed in the region of 30 percent (compared with an industry average of 13 percent in the United States and 14 percent in the United Kingdom). These returns are made possible mainly by the sheer number of people using the shops. Although individuals still have relatively little to spend and prices are moderate, Chinese department stores achieve one of the highest rates of space productivity for department stores in the world. Wang Fu Jing in Beijing, for example, boasts sales of $11,500 per square meter, compared with a weighted average of $3,600 for UK department stores. Even if further store openings erode margins by leading to rent increases and less favorable manufacturers terms of trade, department stores should be able to maintain high returns through increased consumer spending and more efective merchandise management. The key is to ensure high trac by positioning stores for mass appeal.

Further opportunities
Department stores are not the only investment opportunity. The high proportion of consumer spending that goes into food and daily necessities, along with the countrys fragmented retail structure, creates vast potential for chains

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of grocery, personal products, and convenience stores. Hong Kong-based operators and several local companies have recognized this and are beginning to establish grocery chains in and around Guangzhou and Shanghai. In addition, large discount-oriented general merchandise and grocery stores, such as hypermarkets, warehouse clubs, supercenters, and cash-and-carry operations, are emerging as attractive retail formats. The early success of Carrefour, Makro, and Wal-Mart indicates that the Chinese are ready for modern, large-scale outlets. In Shanghai, a scaled-down version of a European hypermarket is achieving returns of more than 50 percent (even though most customers can buy only what they can carry, because they do not have cars). Experience elsewhere in Asia suggests that retail formats such as specialty and discount stores can penetrate even little-developed markets. Makro, for example, has become one of Thailands largest retailers and is currently the eighth-biggest listed company there. In a rapidly developing market like Chinas, it is worth noting that such stores could ourish without damaging established retailers, at least initially. In Taiwan, for instance, local department stores are still growing protably 10 years ater liberalization opened the oodgates to foreign investment in both modern, specialized retailers and department stores. In grocery retailing, the arrival of discounters initially hurt mainly distributors and small traditional retailers, and it was only when growth in food consumption slowed that supermarket chains were afected. The competition Expansion in the number of department stores in Chinas three biggest cities is likely to lead to temporary oversupply, particularly at the top end of the market. In Beijing, for instance, the number of large foreign-operated or locally run department stores has grown from 18 to 53 in three years, and the authorities have now frozen the issuing of licences for them. These cities have received the most attention from foreign retailers. But there are at least 40 cities in China big enough and now wealthy enough to ofer attractive opportunities to local and foreign investors. With rapid economic growth, another 60 cities could represent attractive markets by 2005 (Exhibit 5). Many remain virgin territory. Although the creation of massmarket local chains is encouraged and 40 cities now permit foreign operators, few retailers have expanded beyond the biggest centers. Despite planning nationwide businesses, strong, well-known local companies such as Shanghai Yibai and Hualian, have so far opened only a few outlets, mostly near their home provinces. Even Japans Yaohan perhaps the most ambitious foreign retailer in China has managed only 30 outlets of the 1,000 it plans nationwide.

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Exhibit 5

The market importance of Chinas top 100 cities

Retail spending per capita
$

Population
Percent

Retail sales
Percent

Large local department stores* per city

Average number

Top 3 cities Next 37 cities Next 60 cities Rest of China

2 5 6 87 100% = 1.2 billion

9 20 14 57 140 100% = $250 billion 470 820

1,070 3 1 0

17

* Top 200 local department stores Source: China Statistical Yearbook, 1996; All China Database; interviews

The market presents challenges: the diculty of negotiating licences and sites and the slow pace of establishing sourcing networks are two of the most common. But investors still wary of commitment should weigh the problems against the advantages of taking an early position. First movers are likely to be rewarded with good sites at favorable rents and to be able to cement local relationships that latecomers will nd tough to replicate. And with Chinese ocials still ambivalent about the degree of foreign participation they should permit, the window of opportunity for entry may close (at least temporarily), giving those already inside a gestational period free of intense competition. Above all, investors should bear in mind the pace at which Chinese consumer markets have developed, and act.

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