People power

 

What does China’s rampant consumption mean for the economy? China Connect spoke to Min Tang of the Asian Development Bank to find out…

 

According to recent analysis by Morgan Stanley, China’s consumption could become a stable source of profit over the next few years; retail sales reached around US$625 billion last year, and clearly, the retail, tourism and food service industries are all booming. But what is behind this growth? And what does it mean for both domestic and foreign firms looking to capitalise on these rapidly expanding sectors?

 

Mr Min Tang is Chief Economist at the ADB’s Resident Mission in China. Here, he talks to China Connect about the rise of consumer affluence in the country and how this is impacting on the retail and hospitality sectors.

 

CC. Chinese consumers are becoming increasingly affluent. What factors are behind the rise of the so-called middle class? And how is this important societal group helping to drive China’s booming economy?

 

MT. There are a number of important factors behind this phenomenon, and the first is the fast economic growth of China as a whole – not only in terms of GDP, but also in terms of rising income levels. People have more money, so they are consuming more – and because they are consuming more, it becomes increasingly important to produce more to satisfy demand. Consumption has thus become an extremely important pillar of the Chinese economy, and because the market is so huge it is also becoming a demand-driven economy as purchasing power rises.

 

Another aspect is people’s growing aspirations. People in China work hard because they want to improve their quality of life, and the consumption of an increasingly varied selection of products and services reflects this desire.

 

Previously, the majority of China’s wealth belonged to a small group of people; however, statistics have shown that by 2003, GDP per capita had risen to an average of US$6000 in some cities, such as Shenzhen and Xiamen, and is set to rise even further in the coming years. Because purchasing power parity is quite high in China, these figures are even more impressive. You only have to add together a few of the cities with GDP per capita of US$5500 and above (including Xiamen, Shenzhen, Guangzhou, Shanghai, Beijing, Hangzhou and Suzhou, for example) and already you are talking about 40-50 million consumers with high disposable income, which represents huge purchasing power.

 

Everyone has always known that China is a huge market with great potential for future growth; however, some of that potential is now starting to be realised.

 

 

MT. The key thing to remember here is that the rapid growth in consumer power is very much centred around the coastal and larger urban areas in China; there is still a huge proportion of the population in the rural areas and small cities whose incomes are still quite low, and average GDP per capita across the whole of China is around US$1000. In this sense, one of the potential pitfalls of China’s recent rapid growth is that supply could outstrip demand, because the high-power consumer base is too small to sustain growth and production at the current levels. If this trend is allowed to go unchecked, it is possible that income disparities could actually become more pronounced in the future, which will work against sustainable growth. So there is certainly some work for the government to do in terms of creating a broader base of high-income consumers.

 

Rural incomes in particular are very important as they represent around 800 million people. The purchasing power of this rural population will be critical for building sustainable consumption development.

 

CC. So what can be done to reduce this disparity between urban and rural populations?

 

MT. There are several important measures that can be taken to improve this situation. The fundamental issue is that there are too many farmers in the rural areas, making up around 60 percent of the population. If you compare this with other areas of the world currently at the same level as China (i.e. with a per capita GDP of around US$1000), most countries at this stage of development have an urban population of at least 50 percent, so China still has some ground to make up. Currently, for every dollar produced by the rural population, the urban population produces 3.5 dollars. If 10 percent of the rural population moved to the cities, this would represent about 130 million people – imagine the jump in productivity that would occur if they could maintain the same rate of production! So the first priority is to speed up urbanisation, whilst at the same time creating extra jobs by promoting the small and medium sized enterprise (SME) market and the service sector.

 

Secondly, even in rural areas there are opportunities, but investment is generally sucked into the cities; without financial support, the rural population cannot make the most of the opportunities available. So the government also needs to think about reforming the rural financial system, and should put in place a support system to help rural industries and rural economic development. This would mean that those who remain in the rural areas can produce more, which will in turn generate more income so they can consume more and support greater consumption and development.

 

CC. And what does this mean for both domestic and foreign firms looking to benefit from this rapidly expanding retail sector?

 

MT. Over the last few years, retail sales have grown very quickly in China; a lot of big shopping malls have opened up, so there are lots of opportunities for firms of all sizes. The key to success in this market, for both domestic and foreign firms, is to get their positioning right. The market is not unified: it has different layers. So they have to have the right strategy because competition will certainly be increasing over the next few years.

 

Companies should not underestimate the potential or the purchasing power of this market; after all, even one percent of the total population still represents a market of 13 million people! This is larger than some countries in Europe and elsewhere, so there is a huge market here for both foreign and domestic companies. The middle/lower income markets are even bigger, although they still need time to develop. Consequently, companies need to display patience and think long-term, or alternatively employ a strategy of mass production: manufacture on a large-scale, but with a low profit margin for each product.

 

No other market has the same scale as China, therefore foreign companies will have to employ a slightly different strategy than the ones they employ in other global markets.

 

CC. Do you think Chinese consumers are becoming more Westernised through exposure to Western brands and tastes? Or do they prefer homegrown brands and products?

 

MT. I think it depends on the type of product. Because of WTO entry and the rise of the ‘global village’, people are far less likely to make distinctions between domestic and foreign brands, especially in terms of consumer products. As long as products meet demand in terms of having the right taste and/or best quality, consumers (particularly the younger generation of consumers) will become less concerned about whether they are buying a national or international brand.

 

One thing we have to bear in mind is the consumption behaviour of different generations. Currently, the majority consumer is probably older or middle-aged – someone who has lived through periods of hardship, who is more inclined to save their money than spend it, and who consumes traditional products. However, the young are the consumers of tomorrow – in five or 10 years, the current generation of teenagers will be salaried consumers, and their tastes are totally different. I don’t think this new generation of consumers will differ that much from those in other countries in terms of consumption behaviour and their tastes.

 

So, to go back to your original question, a lot will come down to the type of products being offered and the particular market you are aiming for. If you are targeting the older consumers you will have to cater to certain local, traditional tastes and sensibilities; however, if you are targeting the younger generation, they are probably not so concerned with this.

 

 

MT. Fundamentally, Chinese companies need to learn more from global companies. Of course, it really depends on the product; in many cases, Chinese companies already have an established brand as well as a lot of experience in the market. However, the majority of companies still have a lot of work to do. Chinese producers and manufacturers need to learn international best practices and learn how to compete effectively; in the short-term, their target market will be lower and middle income consumers rather than the high-end market and they will need to target their products appropriately. As I said earlier, they will need to position their products correctly, and build growth incrementally – it’s no use jumping straight in at the high-end, as they will be competing directly with global, prestige brands.

 

On the other hand, domestic companies do have a distinct advantage: they know the local situation well. They have a good knowledge of local networks, can source cheaper labour and distribution, and so in this sense their costs should be a little bit lower. So really it’s about exploiting and capitalising on the areas they are proficient in, and avoiding the areas in which they have a competitive disadvantage.

 

CC. According to some analysts, tourism is another industry set to experience rapid growth over the next few years. How do you expect retailers and those in the hospitality sector to capitalise on this expansion?

 

MT. At the moment, vacation periods (and consequently, domestic tourism) are concentrated around three dates in the calendar: Spring Festival, May Day and the National Day. So everyone takes their holidays during these periods, and tourism is concentrated around these dates. However, many people – including certain elements within the government – are now considering whether this should be changed so that people are free to take their holidays whenever they wish, all throughout the year. This will obviously change the nature of tourism in China: the market will become bigger, and we will see higher consumption.

 

The other thing that could seriously impact on this market is the rural population. Historically, this segment of the population has not spent much of their income on travel or tourism; however, as the world becomes smaller through globalisation, young people especially will be keen to get out and see other places. They’re not quite at the stage where they can afford international travel, but I think we can certainly expect them to increase domestic travel and this should have a substantial impact on the domestic tourism industry. As I said before, the rural population represents 800 million people: if only one percent of these people begin to travel, it will create a huge new market.

 

CC. Obviously, Shanghai and Beijing are seen as highly attractive markets for foreign companies, but do you think second and third-tier cities could also represent good investment opportunities for retailers and those in the hospitality sector?

 

MT. I think so, certainly. Shanghai and Beijing are popular, particularly amongst foreign companies and investors as these are the most well-known. However, as I mentioned earlier, they are not the richest cities. Xiamen, Shenzhen and Guangzhou are all richer in terms of per capita income, so these all represent great opportunities for growth.

 

I think foreign companies will use Shanghai and Beijing as a starting point for their operations, but if they want to expand their business and capitalise on the best opportunities they will have to look to other cities outside these two. Many investors do not realise the potential of some of these other cities.

 

In terms of consumer affluence, the coastal regions represent the areas with highest purchasing power, and the highest potential for growth. The Pearl River Delta and the Yangtze River Delta have been, and will be, the areas with the highest concentrations of rich urban centres.

 

CC. Finally, what challenges need to be overcome in order for China to maintain the kind of growth rates we have seen in the last few years?

 

MT. It is very important that we consolidate and develop a broader consumption base with growing incomes. If income disparities become wider and a small number of people continue to become richer, we will see that this kind of growth pattern cannot be sustained. You only have to look at examples elsewhere around the world to get an idea of how to successfully sustain growth rates: the most successful countries have concentrated on developing the SME sector, on generating more employment opportunities and on creating an equal development of growth. This is how you sustain growth rates, and countries and governments (as well as companies) that have focused on long-term strategies are the ones that have witnessed consistent growth over a period of two or three decades rather than just one or two years.

 

Over the last few years, China’s entrepreneurial activity has increased significantly, which is a really good sign. As you know, the country is moving from a centrally planned economy to a market economy, and over the past 10-12 years we’ve seen a real development of the private sector, with large-scale private sector growth. If government policy is friendly to this small business environment, these businesses can grow more quickly, generate more jobs and consequently more income – which in turn will drive consumption and drive the economy as a whole.

 

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People power

What does China’s rampant consumption mean for the economy? China Connect spoke to Min Tang of the Asian Development Bank to find out…

 

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People power

According to recent analysis by Morgan Stanley, China’s consumption could become a stable source of profit over the next few years; retail sales reached around US$625 billion last year, and clearly, the retail, tourism and food service industries are all booming. But what is behind this growth? And what does it mean for both domestic and foreign firms looking to capitalise on these rapidly expanding sectors? China Connect spoke to Min Tang of the Asian Development Bank to find out…