Friday, May 28, 2010

China—Incredible Complexity, Unlimited Opportunity

We recently had the unique opportunity to attend the grand opening of the 25th store in Shanghai, China for E-mart, our long-time Korean client. E-mart is an extremely successful Korean hypermarket retailer that, along with just about every other global retailer, has targeted the Chinese market for expansion. In my 25 years of consulting, I have never seen anything like the masses of consumers who gathered to shop this store on a Tuesday morning. I was assured that the crowds would be much more substantial on the weekend. It made Black Friday in the U.S. look positively tame by comparison and recalibrated the notion of what crowded really means:

Figure 1: The throngs at E-mart's Opening

There is obvious opportunity in the market, with 1.3 billion people and a rapidly growing GDP. The opportunity is so evident, in fact, that China has attracted the interest of just about everybody of global scale. This includes Wal*Mart, Carrefour, Metro and Tesco, the four largest retailers in the world in order as well as an impressive list of other Asian competition and a host of local Chinese companies. Further complexity ensues when analyzing the business by region (different competitive dynamics are in place depending on the geography) and by city. The fact that there are literally dozens of Chinese cities with populations in excess of 1 million people is equally mind-boggling. Fun fact: there are 24 cities larger than Chicago (populations in excess of 3 million).

However, this opportunity brings intense competition and a vast array of cultural and geo-political issues that make success in China far from a sure thing. First, the competition in the market is extremely strong. We were extremely impressed by RT Mart (a Taiwanese competitor with 150 or so stores in the market partially owned by French giant Auchan), which had outstanding execution in fresh foods. Fresh in China really means “fresh”, often live, with as few barriers between customers and the product as possible:

Figure 2: A look at RT Mart's Produce Department

Equally impressive is Carrefour, the French hypermarket retailer that was an early pioneer in the China market and nominally the market leader. They essentially created the notion of what a hypermarket is in China. One of the units we visited reportedly does in excess of $200 million per year (and we believe it based on the crowds and merchandise density observed). The store’s high service levels (mostly staffed by suppliers) and incredible breadth and depth really stood out:

Figure 3: Carrefour's Wall of Shampoo

In general, the market is defined today by price. From a retail standpoint, there is little regard for inventory productivity or much sophistication with technology. Labor is so inexpensive and readily available that sheer manpower keeps the store in good operating order.
While the GDP is indeed increasing, it stands today at about $7,000 per capita. This number is deceiving on a number of levels given that there is vast disparity in income among regions and among consumers within the region. The GDP in Shanghai is nearly double the national average reflecting greater prosperity but there still remains a huge divide among the haves and have-nots with a growing but still scarce middle class.

While there is a rush to entry, and big expansion plans named by the majors, no one really occupies a definitive position today. A vast majority of the market is still done in unorganized trades in mom and pop retailing and wet markets that are prevalent everywhere. The last time we saw any market share figures, the leading chains have somewhere in the neighborhood of 2% share. While it is impossible to really gain a measure of profitability, high development costs and razor thin margins don’t bode well for short term profitability.

To further complicate matters, navigating the China market requires an in-depth understanding of local markets and the rules (or lack thereof). There are dozens of unwritten rules that govern the market and there is a distinct bias towards the success of local companies who can more effectively navigate the labyrinth. As an example, Walmart is still having issues with its Trust Mart acquisition even after a year. From a true macro standpoint, it is important to remember that China remains a communist run state and the geo-political climate is far from stable. That said, there is no doubt that China is well on its way to becoming the world’s largest economy. In a year when the global economic output decreased by nearly a percent, China’s grew nearly 9%. It is scheduled to grow by double digits into the foreseeable future. At that pace, China is destined to become the world’s largest economy in the next thirty years (passing Japan in the next decade).

As we said in our headline, incredible complexity combined with almost unlimited opportunity. While not for the faint of heart, China might well represent the greatest growth opportunity for retailers (and suppliers) for the foreseeable future.

1 comment:

  1. and a you tube link to the opening...