TELEGRAPH COLOUR LIBRARY

DEVELOPING MARKETS

have
long poured investment into China,
driven by visions of the countrys
billion consumers and the belief that first
movers will reap a permanently disproportionate share of one of the twenty-first
centurys biggest markets. In one market
in particular, packaged foods, the scope is
undeniable: in 1998, packaged food will
account for 20 percent of the countrys
$200 billion food and beverage sales, or
$40 billion. Sales of some items, such as
milk powder, instant noodles, biscuits, and
sot drinks, have already topped $2 billion.

ONSUMER GOODS COMPANIES

Yet despite this potential, most foreign

food and beverage companies are finding it dificult to attain even modest
profitability in China. Pre-tax returns on
invested capital for the 2,500 largest food
and beverage joint ventures were less
than 6 percent in 1995.* Even among the
200 largest joint ventures, average returns
were only 3 percent for those operating
for three years or less, and around 10
percent for those in operation for four or
more years (Exhibit 1) certainly below
the risk-adjusted cost of capital for China.
Moreover, returns among these ventures
vary enormously, from minus 36 percent
to 60 percent.
These erratic results, coupled with the
Asian economic crisis, are prompting
investors to look closely at their performance in China. Many are realizing that
their businesses are not well positioned
* The last year for which data are available. The figure
excludes wholly foreign-owned enterprises, which
could account for another $1 billion in direct foreign
investment in food and beverage processing.

James Hexter
Javier Perez
Anthony Perkins

Can you make money

in Chinas packaged
food market?
There are many recipes
for disaster
Three lessons: price for
high afordability, rush
for scale, and invest in
people, not assets

Jimmy Hexter is a consultant in McKinseys Hong

Kong ofice, Javier Perez is a principal in the London
ofice, and Tony Perkins is a principal in the Beijing
ofice. Copyright 1998 McKinsey & Company. All
rights reserved.

THE McKINSEY QUARTERLY 1998 NUMBER 3

59

GOLD FROM NOODLES

to be profitable. Some are

lowering their growth expectations and postponing
Range of pre-tax ROIC, 1995, percent
option-creating
investments
Mean
30
while they search for a suc25
cessful formula. One execu20
15
tive of a multinational com10
10%
pany
earning less than 6
5
3%
percent pre-tax return on
0
5
capital ater 10 years in China
10
sums up the situation thus:
15
We
are still in China. Our
20
25
business has been doing reaYear
1995 1994 1993 1992 1991 1990 1989 1988
sonably well, but it has been
Ventures
11
23
37
34
10
11
7
67
launched
a long, tough struggle. This
company has abandoned the
once-popular one by two goal $1 billion in sales by 2000 and settled for
a target roughly one-fith of that sum.
Exhibit 1

Profitability of the 200 largest food and beverage

joint ventures

Our work with consumer companies and recent McKinsey research reveal
the causes of these dificulties and highlight key decisions that those
striving to build profitable businesses in China must make. The research
involved reviewing the reported performance of 2,500 joint ventures in
packaged food, and studying the more prominent ones in detail. We
interviewed senior executives from 20 multinational, Asian, and Chinese
packaged food companies, and benchmarked the finances and operations
of 13 of these companies.
Our research identified a small group that has built initially successful
businesses by mixing five key ingredients for success, but no single player
exemplifies best practice along all dimensions. Indeed, the lesson appears to
be that China is such an unforgiving market that only a few broadly based
companies with extensive international experience are likely to possess the
skills, resources, and stomach to succeed on their own during the early stages
of market development. Those less well endowed might consider alliances as
a way of complementing skills and sharing risk, or simply find inexpensive
ways to learn about the market before they commit themselves.

Recipes for disaster

Chinas processed food market has a rich and complex competitive landscape in which most prominent Asian and multinational food companies
are staking a claim. Their approaches to product positioning and their
mindsets vary widely and have profoundly influenced their performance in
China thus far (see the boxed insert, The market contenders).

60

THE McKINSEY QUARTERLY 1998 NUMBER 3

THE MARKET CONTENDERS

hinas packaged food market features

an intriguing mix of competitors, from
Western and Asian multinationals involved
in single or multiple categories to local
competitors and entrepreneurs with niche
businesses. These players vary widely in
their aspirations, resources, and experience
in emerging markets, and as a result have
taken very different approaches to the
Chinese market (see exhibit):

successes at home. They see its opportunities

as rightfully theirs, and some view victory in
China as a means of attaining international
stature. Having gained recent experience of
evolving categories, Asian companies often
appear more willing than multinationals to
participate in commodity products where
prices are low and margins razor thin.
Home-market defenders, most of which
sell low-priced commodities and have weak
brands, are struggling to defend their home
turf. There are, however, notable exceptions.
In non-alcoholic beverages, for example,
progressive companies such as Nowada
and well-known brands such as Jianlibao
appear to be withstanding early pressures
on their categories.

Multi-category multinationals with a long

history of successful operations in emerging
markets, such as Nestl and Danone, are
building large businesses. Their strategy is
to get as close as possible to mainstream
consumers, typically by providing highly
affordable, value-for-money products.
Single-category multinationals of every
type are operating in China. Some, like
Coca-Cola, are striving for broad appeal
through affordable pricing and ambitious
expansion. Others are seeking profitable
growth at the premium end of the market.
Many have limited experience in emerging
markets and are finding China tough going.

Entrepreneurs and other option creators

with relatively small businesses (sales of up to
$10 million) are skimming the premium end of
the market. Their success hinges on importing
to begin with, relying on international
distributors to cover a few high-profile
outlets, and spending little or no money on
advertising. At some point, they expect to
exercise their option, either by selling a solid
market position to a more aggressive player
or by moving to local production and selfdirected distribution.

Asian attackers, and particularly Taiwanese

players such as President Foods and Wei
Chuan, are attempting to replay in China their

Some approaches to product positioning

Main focus
of study

Main competitor groups

Home-market
defenders

Multi-category
multinationals

Single-category Asian
multinationals attackers

Premium
skimmers

Danone (Evian)

Cerebos
Lee Kum Kee
Pillsbury
Sara Lee

High-end
market
developers

Danone (Amoy) Kraft

Nestl (coffee) Heinz
Frito-Lay
Kelloggs

Nissin

Hai Kou Can

Jianlibao

Value-formoney
adapters

Nestl (most)
Danone
(biscuits)

Nabisco
CPC
Unilever
(Walls, Lipton)
Quaker
United Biscuits

President
Ting Hsin
Yeos
Wei Chuan

Ruida
Nowada
Meili

Coca-Cola

Hua Feng
Red Star

Mass-market
producers

Option
creators
Rougemont
Great Lakes
Smucker
Ferrero
Dumex
Cadbury
Lao Cai

THE McKINSEY QUARTERLY 1998 NUMBER 3

61

GOLD FROM NOODLES

The sharpest contrasts emerge if we compare the diferent approaches that

Asian and multinational companies take to China, and their results. Asian
companies are almost twice as likely as multinationals to achieve a minimum
threshold return on invested capital during their first four years of operation,
although they are only fractionally more likely to experience success later
(Exhibit 2). These findings reflect clear diferences in approach and operating
styles. There are advantages and disadvantages in the way both sides function.
Asian companies have quickly become profitable by selling afordable
products, expanding their distribution coverage rapidly, and employing
low-cost yet initially efective
Exhibit 2
organizations. But the subMultinationals versus Asian companies
sequent failure of many to
Example: Food and beverage JVs with revenue exceeding RMB15 million
build strong brands and
Number
Less than 4 years in China
manage distribution tightly
of joint
ROIC <10% ROIC >10%
ventures
has undermined this early
21
79
42
Asian
success. One Asian-funded
45
29
Non-Asian 55
joint venture that enjoyed a
More than 4 years in China
leading market share in the
ROIC <10% ROIC >10%
early 1990s underinvested in
Asian
36
64
25
its brand franchise and distriNon-Asian
40
60
10
bution network, leaving itself
vulnerable to savvy marketing from a new competitor. It now comes a distant second in both sales and
brand awareness.
Meanwhile, the multinationals are grappling with a diferent set of issues.
Several have introduced products from their home markets that require the
Chinese to adopt new eating habits. The result: low early demand. Some are
discovering that traditional resource-intensive approaches involving large
fixed asset bases and prolonged expatriate deployment have done little to
boost growth in demand. And some have compounded their problems by
building state-of-the-art manufacturing facilities and inadvertently investing
substantial working capital in trade credit.
Yet against this somber backdrop, a small number of companies stand out.
They have found the ingredients for profitable and sustainable consumer
franchises. They range from Chinese township- and village-owned enterprises
to Asian entrepreneurial startups and multinationals with global products
and brands.

Five ingredients for success

The winners in Chinas packaged food market seem to be doing five things
right. They select structurally advantaged categories, price at value-for-money

62

THE McKINSEY QUARTERLY 1998 NUMBER 3

GOLD FROM NOODLES

levels, build scale quickly, invest in local marketing, sales skills, and organizations rather than assets, and build enduring brand equity.

Select structurally advantaged categories

The choice of product category can determine early profitability: no amount
of excellent execution can compensate for a bad decision about where to
invest. Our research suggests good companies can achieve returns on investment of 25 to 35 percent or more in structurally advantaged categories,
whereas even the best performers in disadvantaged categories struggle to
recover their cost of capital.
Advantaged categories have three defining characteristics: immediate
acceptance by a large base of consumers, high afordability, and suficiently robust economics for market leaders even in the face of rising competitive intensity.
Consumer acceptance is a critical driver of profitability. Our work in emerging food markets has identified four levels of challenge in category development. In the most dificult categories, such as breakfast cereals, companies
must encourage consumers to try entirely new tastes, textures, and usage
occasions. Attempts to form new eating behavior must be supported by
education, and typically result in slow rates of trial and adoption. Under these
conditions, geographic coverage must be broad to achieve even marginal
scale, a necessity that erodes financial returns.
Only slightly less dificult are categories requiring consumers to convert
from home-made to bought products such as canned soup. Inducing trial
and repeat purchasing is much less expensive in categories in which consumers simply replace an existing purchase with a similar product: potato
chips instead of salty fish snacks, for example, or baby cereal instead of
congee. Naturally, products already widely embraced by consumers, such
as biscuits or fruit juice, require the smallest amount of investment in
consumer education.
Product afordability drives volume growth. The average income of Chinas
370 million urban residents, the target of packaged food companies, was only
$52 a month in 1997. Categories such as sot drinks, noodles, and biscuits are
easily afordable at about 25 to 50 per purchase unit, whereas cheese and
dry breakfast cereal, which cost more than $2 a unit, represent a higher
hurdle. Similarly, bouillon and chicken powder, which sell at a 300 percent
premium over monosodium glutamate, can currently be targeted at only a
small fraction of households even in Shanghai, one of Chinas wealthiest cities.
It may be years before these products are widely adopted. Manufacturers
are trying to overcome the barriers by ofering smaller sizes, but Chinese
shoppers have shown limited interest in small packs ater trying them once.

THE McKINSEY QUARTERLY 1998 NUMBER 3

63

GOLD FROM NOODLES

Advantaged categories must thus feature products that consumers are

comfortable using and that they can aford (Exhibit 3).
Exhibit 3

Returns by category
More challenging

Less challenging

(%) 1995 ROIC

Breakfast
cereal
Low
(>15RMB)

Cheese

Peanut
butter
Fruit
yogurt

Western
prepared
soup
Coffee
Medium
(515RMB)

High
(< 5RMB)

Chewing
gum

Create new
demand

Premium
ice-cream
Jam
Potato
chips

Tea bags
Frozen
dumplings Powdered
milk
(10%)
Powdered
drinks
(12%) Bottled
water
(1.8%)

Convert from
home-made

Bouillon

Premium
soy sauce

Western
Chocolate
fruit juice
Baby
cereal
Ice-cream
Biscuits
Beer
(9.5%)
(3.2%)

Bouillon
MSG
blends

Rice Asian
Yogurt
drink crackers sauces
Instant
Soft
noodles
drinks
(12.3%)
(7.2%)

Replace existing
category

Upgrade existing
category

Development challenge

Robust economics are critical to sustainability in the face of rising competitive intensity. Categories such as beer and noodles are becoming
structurally unattractive because of overcapacity, falling prices, escalating
advertising spending, and demands from channels for lower prices and more
support. In beer, one of the most overcrowded categories, capacity utilization
stands at only 60 percent, and advertising expenditure per premium beer
drinker has soared to about $14 a year about the same as in the United
States. It is no surprise that brewers average return on invested capital is
about 3 percent, and that ater-tax margins for some leading competitors
declined by 7 percentage points between 1995 and 1996, the year the
downturn in the beer industry began.
It is likely that the structure of individual food categories in China will evolve
in the same way it has in other developing markets. The number of profitable
competitors in a given category at maturity is a function of several factors,
including asset intensity, the importance of technological innovation, and the
degree of product diferentiation. Experience from more mature markets
may serve to predict profitability in China. Japans number 1 noodle maker,
for example, has a 9 percent pre-tax net margin, while the number 4 player
has a margin of 2 percent. Before joining the fray, potential entrants into
Chinas noodle market might consider whether the category will develop
acceptable economics for market leaders and assess their own chances of
attaining a solid top three position.

64

THE McKINSEY QUARTERLY 1998 NUMBER 3

GOLD FROM NOODLES

The questions for investors are: how much industry surplus is up for grabs,
given the competitive situation? Can we capture enough share to earn
attractive returns in the short term? What will the industry structure be once
the market matures? What are our chances of surviving as a profitable market
leader five or 10 years from now?

Price at value-for-money levels

As already noted, afordability is critical to widespread consumer adoption.
Selecting an appropriate price band is thus the second critical strategic choice.
Our analysis suggests that value-for-money pricing at 30 to 60 percent above
mass-market rates ofers the best guarantee of broad market appeal.
In the case of several popular products, namely instant noodles, biscuits, soy
sauce, and sot drinks, four broad price bands are emerging (Exhibit 4):
Exhibit 4

Emerging price bands in four categories

Premium over mass-market products, percent
Instant noodles

Biscuits

Soy sauce

President

Monde Lemonia

Lee Kum Kee

Premium

Soft drinks

Hoping
Premium
skimmers

Jin Lan
Kangshifu
Hoping

Zonmau Coconut

Rougemont

Kantolan

Great Lakes

Lotte

200%

McVities
Amoy Golden

High-end
market
developers

100%
Value-for-
money
adapters

Nissin Beef

Zheng GuangHe

Garden Pop Pan

SF Cream Cracker
Hai Kou

President Black Pepper

Nissin Damae Ramen
Michi Black Pepper
Kangshifu
President
Kangshifu

Amoy Fresh
Keebler Pacific
Nabisco Oreo
Danone
Nabisco Ritz
Danone Tianqu

Lao Cai (high-end)

Quaker

Jammy Chai
Lao Cai (bottle)
Tai Tai Le

Jianlibao

Seagull

Coca-Cola

Amoy Bean
Lao Cai (bag)

President

Michi Beef
25%
Mass-
market
producers

Fu Man Duo
Hua Feng

Khong Guan
Lihua
Meili

Mass-market pricing is usually set by Chinese state-owned enterprises

(SOEs) selling largely undiferentiated, low-value-added products. It typically yields a gross margin insuficient to cover a salesforce of adequate
size or competitive advertising and promotion. Typical SOE cost structures
accommodate gross margins of no more than 8 to 10 percent. Only a few
multinationals, such as Coca-Cola, can sustain a business while pricing
at this level.

THE McKINSEY QUARTERLY 1998 NUMBER 3

65

GOLD FROM NOODLES

Value-for-money pricing, the approach chosen for many popular products

such as Nabiscos Oreo cookies and Jianlibaos sports drink, is defined as a
premium of up to 100 percent over mass-market levels. While the economics
of each category and each company are unique, our research suggests that a
premium of approximately 30 to 60 percent appears to strike the best
balance: afordable yet aspirational for consumers, while generating suficient
margins and scale to fund market development. Pricing at this level oten
means selling products for much less than in developed markets.
High-end pricing involves a premium of 100 to 200 percent over massmarket levels. In many cases, this inhibits demand. Foreign beer brands, many
of which are high in price, together command only 2 percent of the market in
Beijing, 12 percent in Shanghai, and 24 percent in Guangzhou. These regional
disparities are partly the result of diferences in wealth; a more important
factor is the trend for greater acceptance of foreign goods in the south of
China than in the north. Some of the most troubled companies in our survey
price in this range despite having built the infrastructure to handle the volume
of a lower-end product.
Premium pricing is pitched at more than 200 percent over mass-market
levels. Companies that choose to price this high are likely to remain niche
players; indeed, this approach may be sustainable only for true premium
global brands such as Evian water.
Our examination of the pricing policies of 35 companies revealed that those
pricing at no more than 100 percent over mass-market products outperformed those charging a higher premium. They also tended to outperform
the average return for their category by a wide margin.
A tiered portfolio approach to pricing can raise overall category profitability.
Noodle makers, for example, ofer packet noodles at a value-for-money
price point and bowl noodles in the high-end and premium bands. A wellpositioned soy sauce brand such as Lao Cai (developed by an overseas
Chinese entrepreneur) has an entry-price product for mass appeal and several
tiers of higher-value products to which consumers can trade up.
This approach has clear benefits. Value-for-money products generate suficient
volumes and gross margins to support brand building and sales infrastructure.
High-end and premium products provide additional gross margins and
position a company for the inevitable evolution of consumer demand.

Build scale quickly

The third key choice is the breadth and pace of volume growth and geographic expansion. Our survey indicates that large companies do it better.
Analysis of five food categories revealed that only the biggest 10 percent of

66

THE McKINSEY QUARTERLY 1998 NUMBER 3

GOLD FROM NOODLES

ventures were earning positive returns in two categories.

In the other three, only the
top 25 percent were profitable (Exhibit 5). Companies
sustaining high profitability
beyond their fourth year of
operation were more than
five times larger than those
racking up losses.

Exhibit 5

Average revenue and ROIC by category

Joint ventures in key packaged food categories
Largest 10%

Next 15%

Rest

Average revenue

Average ROIC

$ million

Instant
noodles

Percent

58

Carbonated
drinks

17
7
<10

12

52
24

9
<1

Biscuits

22

11
12

9
<3
Scale is all-important in a
Culinary
9
7
large emerging market like
products
2
7
China. Widely dispersed con<7
sumers with limited spending
Monosodium
32
5
glutamate
13
1
power; fragmented retail,
<3
distribution, and media channels; and scarce local talent
throughout the industry chain make the country a costly place to do business.
Channel and media fragmentation and limited afordability translate directly
into abnormally high channel markups, low net price realization, and low
invested capital productivity. Coupled with skill gaps and rising competition,
this fragmentation also results in high levels of sales, advertising, and
promotion expenditure and working capital requirements.

As we saw, selecting categories with high consumer acceptance and ensuring

afordability through value-for-money pricing are prerequisites of rapid
growth. That said, some companies are achieving impressive growth by
expanding rapidly, organizing their geographic rollout sequentially,* and,
where feasible, operating in several categories.
Notwithstanding investors claims to the contrary, rapid geographic rollout is
possible. Two companies from our sample, one in the dairy business and the
other in culinary products, managed to reach the required scale for their
respective categories within three years. For the former, this translated into
10,000 outlets with 42 distribution managers in 26 cities; for the latter, 40,000
outlets with 83 distribution managers in 60 cities. Noodle manufacturers are
managing to reach 300,000 to 500,000 outlets across 100 cities nationwide
within five years.
Rapid rollout is becoming more feasible largely because Chinese distributors
have come a long way in a short time. Five years ago, few local distributors
had suficient physical delivery capability, let alone merchandising skills, to
* See Jim Ayala and Richard Lai, Chinas consumer market: A huge opportunity to fail?, The
McKinsey Quarterly, 1996 Number 3, pp. 5671.

THE McKINSEY QUARTERLY 1998 NUMBER 3

67

GOLD FROM NOODLES

meet the needs of most food multinationals. Today, many cities have several
reliable distributors. As a result, lack of physical distribution is no longer the
main brake on geographic expansion; rather, the scarcity of the management
time needed to build and monitor sales and merchandising across far-flung
markets is to blame.
Recognizing this constraint, successful companies are building scale by means
of a sequenced city rollout and carefully managed distribution. Most begin by
building a presence in a single region or cluster of cities, then attack others in
succession using cash from markets in which they have dominant shares.
Sequencing ensures best use of management time and advertising spending,
which oten has spillover efects in nearby cities. It also enables lessons
learned in one place to be applied in the next.
As well as rolling out products rapidly, successful companies are taking
control of distribution by removing layers of distributors and deploying sales
teams to monitor distributors performance and build skills. They also directly
serve emerging grocery chains and hypermarkets, which account for about
9 percent of food sales in Chinas top 100 cities.* Nabisco, for example, enters
a new city by selecting the most capable distributor, then providing staf to
shadow manage and build the distributors skills in retail outlet management. New entrants may want to consider piggybacking distribution on top of
established multinationals in non-competing categories, or find a local thirdparty distributor with a record of serving multinationals. Another possibility
is to use logistics companies.
Companies willing and able to participate in multiple categories in China,
such as Nestl, President Foods, and Danone, can not only amortize their
fixed costs across a broader range of products but also gain a bigger share
of a distributors business. This translates into clout. One Chinese beverage
company whose core product represented as much as 20 percent of its
distributors profits was able to launch a new product category by persuading
them to drop competitors lines.

Invest in marketing and sales organization rather than assets

The fourth strategic decision is where to focus resource investments. Our
research suggests that divergent approaches to people and asset use may yield
surprisingly similar market results.
Two companies making culinary products built similar businesses between
1994 and 1996. Each achieved broad city and outlet coverage, generated about
$10 million in revenue, and earned comparable gross margins. But their ways
of deploying resources were radically diferent, and produced contrasting
* If we assume that all such modern-format stores are in the top 100 cities.

68

THE McKINSEY QUARTERLY 1998 NUMBER 3

GOLD FROM NOODLES

net income and ROIC results. One spent six times as much on SG&A as the
other, primarily by employing 27 expatriates against the others four, and
used four times the capital. The other ofered equity incentives to keep local
salaries low and outsourced capital-intensive but low-value-adding manufacturing steps to reduce capital investment. This company is now a market
leader with near breakeven ROIC, while its competitor struggles with an
ROIC of 30 percent.
Companies that succeed in China seek to build marketing, sales, and distribution skills in increasingly local organizations. The efective transfer of
brand marketing skills is essential, but brand
development must be grounded in a locally
Some companies saddle
adapted consumer proposition. Profitable
their China operations with
firms avoid prolonged dependence on expenworld-class but oversized and
sive expatriates by hiring the best local
overengineered white elephants
people and honing their skills, taking advantage of the increasing number of Chinese
returning from work or study abroad and the growing pool of local managers with multinational experience. Progressive Asian companies oten
ofer equity or performance-linked bonuses to lure talented people from
their home markets.
Companies oten err in focusing on building factories rather than attending
to critical sales and marketing tasks. Our research underscores the importance of keeping asset levels low: companies with a sales to asset ratio
greater than one are more than three times as likely to achieve an ROIC
above 10 percent. Some companies saddle their China operations with
world-class but oversized and overengineered white elephants better suited
to markets with high labor costs and an eficient logistics infrastructure. One
multinational launching a product new to Chinese consumers built a factory
that will take eight to ten years to fill.
Chinas high distribution costs and the uncertainty over volumes oten mean
that a smart plant configuration will include several small regional factories
rather than a single facility. Using secondhand equipment, adding machine
capacity in small increments, and outsourcing inessential asset-intensive
activities can reduce investment in fixed assets to acceptable levels.
In a market notorious for credit risk and product returns, keeping working
capital tightly reined in is vital. The market leader in one category operates
with five days accounts receivable outstanding, 25 days inventory, and more
than 60 days accounts payable. Its strong brand and rapid growth enable it to
achieve negative working capital levels of up to 30 days. A leading competitor,
by contrast, has 10 days accounts receivable, 60 days inventory, and only 40
days accounts payable, and must fund 30 days of working capital by itself.

THE McKINSEY QUARTERLY 1998 NUMBER 3

69

GOLD FROM NOODLES

Clearly, size counts in this game: the greater a companys market clout, the
more assertive it can be with the trade. Yet experience suggests that even
companies new to the trade can reduce their working capital through hardnosed credit management (by demanding cash on delivery or payment on
an earlier shipment before delivery of the next, say) and close attention to
factory and channel inventories.

Build enduring brand equity

In China as in any consumer market, the companies that build strong brands
earn most of the value created by their industry. A case in point is Tingyi,
whose Kangshifu brand of instant noodles commands 25 percent of the
market by volume and 35 percent by value. Having started out in 1992, Tingyi
now rings up more than $600 million in annual sales. While competition has
reduced ROIC from more than 40 percent in 1994 to less than 10 percent in
1997, continuing investment in brand building and distribution means that
Tingyis noodle business is well positioned to
sustain its early promise.

Innovation should be
supported by extensive
product testing and the
creative use of pilots

Tingyis initial success was based on a

distinctive beef-flavored product in a unique
disposable bowl. Since then, it has added
regional flavors, new items such as childrens
snack noodles, a wide range of packages, and a number of price points. The
number of noodle stock-keeping units under the Kangshifu brand now extends
to about 70. To build a national brand from scratch, Tingyi spent more than
$60 million on advertising and promotion. This outlay enabled it to buy roughly
50 percent of all advertising in the instant noodle category during its first four
years, and then hold this at a level equivalent to its value share when
competition intensified in the next two years.

Companies such as Tingyi invest to get to know their consumers, then use
this knowledge to drive rapid product innovation and adaptation. One
company introduced a product that consumers treated primarily as a git
item because of its high price. Research indicated that they would buy it for
their own use if the price were lower. Rather than jeopardize the image of
its core product, the company developed a cheaper alternative with a lower
nutritional content to serve as a mass-market brand. It has generated
substantial sales.
Such innovation should be supported by extensive product testing and the
creative use of pilots. Sot drink and confectionery companies have found
they must make their products less sweet to appeal to Chinese consumers.
Many others are finding that local and regional flavors must be added to
make foods more appealing. It is not uncommon for companies to spend up
to two years developing products for the Chinese market.

70

THE McKINSEY QUARTERLY 1998 NUMBER 3

GOLD FROM NOODLES

Successful companies are also prepared to spend on promotion in the face

of mounting competition. Until recently, advertising intensity in China was
low, and companies could build brand awareness and stimulate trial
comparatively cheaply. As little as two years ago, $2 million could buy a
dominant share of all advertising in a category and launch a product on a
national scale. Our survey indicates that companies now have to budget to
spend up to $6 million on advertising and promotion over three years to
launch a new brand in a single region.
Not all of this is money well spent. Common pitfalls include spreading budgets too thinly across regions and brands, and spending heavily on television
advertising for products where trial, repeat purchase, and loyalty are likely
to be built slowly and largely independently of media spending. This is
particularly true in Western food categories, where the amount of consumer
education needed to accelerate product trial and adoption is such that
companies might be better of waiting several years before launching their
products. One culinary products maker hoping to move Chinese consumers
from a traditional but clearly inferior ingredient to one widely used in other
Asian markets spent up to 21 percent of its sales on advertising, with little
impact on trial and repurchase but a massive impact on net margin, which
plummeted to 51 percent.
Companies should be warned, however, that the jury is still out on the efectiveness of early eforts to build brand equity in China. Fickle consumers
allocating their limited purchasing power to an exploding number of choices
may prove harder to retain than to attract. Status and face remain important but unsustainable shapers of early consumer preferences.
Looking ahead, we expect the claim that first movers can build unassailable
brand positions with limited spending to prove unfounded. As in any other
market, only those with the patience to understand the consumer and the
staying power to invest consistently will build real franchises in China.

The five ingredients of success are clearly intertwined. Selecting a product

category that does not yet exist in China and that will require massive
consumer education is unlikely to permit scale, regardless of pricing. And
skimping on investment in brand equity may boost returns in the short term,
but will lead to declining volumes and profits when new competitors arrive.
The challenge is to get the mix of business development strategies and
operating tactics right for all five ingredients.
Although none of the companies we studied has yet achieved this balance,
the stronger performers appear to understand that they need it if they are
to build and sustain a profitable business. The weaker ones, however, oten go

THE McKINSEY QUARTERLY 1998 NUMBER 3

71

GOLD FROM NOODLES

overboard on resources or allow global priorities to drive local business

development. For their part, Chinese and other Asian companies typically
focus on low-cost early market development, yet appear unable to anticipate
and react to rising competition.
The truth is that only a handful of food and beverage companies possess the
skills and resources to succeed on their own in China. The importance of
building scale rapidly and the need to overcome daunting operational and
competitive challenges strongly favor a few broadly based multinationals
such as Danone and Nestl. These companies have both experience in
emerging markets and readily adaptable portfolios.
Multinationals operating in narrow categories, particularly those that have
succeeded by developing streamlined business systems and highly evolved
propositions for sophisticated consumers, should think carefully before
entering China. Some may prudently decide that conditions are not yet right
for them, especially given the state of Asias economy; instead, they can seek
low-risk ways to learn more about the market. Those intent on early
participation could explore alliances with Asian partners, which possess many
of the key skills for early success but appear to lack the depth of branding
skills needed to excel when categories become hotly contested.

72

THE McKINSEY QUARTERLY 1998 NUMBER 3

CHINAS CONSUMER MARKET: A HUGE

OPPORTUNITY TO FAIL?
Chinas market for mass consumer goods has exploded
over the past decade and will continue to grow with
breathtaking speed, outpacing overall economic growth. By
2000, some 260 million people will be able to aford packaged
consumer products, making China the worlds largest market
in many categories such as beer and biscuits. Winning in
China has therefore become a top priority for multinational
corporations, many of which see the Chinese market as a
once-in-a-lifetime opportunity to catapult themselves into
position for global leadership.
But winning wont be easy. Chinas vast area and weak
distribution infrastructure, as well as increasingly intense
competition, will make market leadership an elusive prize.
Many companies are already having to reconsider their
approach to doing business in China, failing to translate
their ambitious aspirations into clear growth trajectories;
in all too many cases, early gains have turned into a
serious drain on resources. It seems clear that approaches
followed so far arent the formulas for success in the
Chinese consumer market of the 21st century. Something
quite diferent is needed.
Jim Ayala and Richard Lai, The McKinsey Quarterly, 1996 Number 3