CHINA: A Nirvana For Producers?

First, some impressive statistics: 1.3 billion Chinese consume 51% of the world’s pork, 33% of the world’s rice and 19% of the world’s ice cream. Indeed, China spells large amounts.

It is very hard to assess the Chinese food market because of its distribution characteristics. Most shoppers go to markets in which scanning does not exist. Ex-factory statistics are also blurred because the Chinese government only keeps track of companies with more than $600,000 in annual sales.

According to a recently published report by the US Department of Agriculture, there are about 19,000 food companies (including processing firms such as rice mills, slaughterhouses, etc.) which account for roughly $123 billion annually. The latter make up almost 60%, while food and beverage manufacturers each take 20% of the market.

Of course, this 40% ($49 billion) represents only a fraction of the potential Chinese F&D market. For example, the Dutch groceries market—China has 80 times more citizens—accounts for $20.3 billion alone.

Speed of sound
This potential only becomes bigger, considering that only 30% of the Chinese food market is made up of processed foods—relatively low by Western standards (80%). China still is very much a fresh market, in which meat, for example, is preferably bought alive.

However, this is changing, especially in urban areas in which busier lifestyles and higher concentrations of wealthy people have led to different shopping and consumption patterns (see Retail spend low).

The rise of foreign fast-food firms and institutional catering is a clear indicator of the Chinese ‘mealtime evolution’. The number of outlets of KFC, Pizza Hut, Taco Bell and McDonald’s is growing at the speed of sound. Foreign catering groups, such as Sodexho and Compass Group, have experienced similar success.

Foreign retail chains such as Carrefour and Wal-Mart also contributed to this evolution, which —due to infrastructural improvements (see Distribution box)—has spread fast from first to second tier cities
Multinational’s nirvana
A huge potential market, an annual population growth of roughly ten million new Chinese, a booming economy and the absence of national brands. All in all, China would seem a multinational’s nirvana. But it is not.

A recent survey among US companies by independent research service China Economic Quarterly shows that not is all fine and dandy in China. CEQ’s editor-in-chief Joe Studwell explains, “Many foreign businesses in China are struggling to make money at all because of low margins and cut-throat local competition.” Several Western dairy manufacturers found that out the hard way, when they started breaking into the Chinese market, say from 1993 to 2003. Parmalat made the mistake of focusing on premium dairy products, which retailed at double the price of similar domestic brands.

Ultimately, the Italian company took several products off the market, because most consumers found better value in domestic brands. When it comes to food, Chinese consumers are very price-oriented.

Rising costs
This price sensitivity is not an absolute phenomenon. Depending on region and age group, the emphasis on price differs. In urban regions and among young consumers, price is less important. Nevertheless, companies should not make the mistake of applying Western standards for their pricing strategies.

The price sensitivity is also reflected in the pricing strategies of foreign retailers. Notably, Wal-Mart’s EDLP (Every Day Low Pricing) has proven to be a viable concept in the Chinese retail market.

Obviously, the dominance of price—even in a growing market— is putting manufacturers under pressure. The rising popularity among retailers to ask for listing fees has not made the situation any better.

On top of this, companies have been confronted with other rising cost components. According to a recent IGD report, transportation costs are already on par with those in Europe, due to the increase in road tolls and licenses. Rising commodity prices for grain, sugar, cocoa and oil, due to rising domestic demand, have not helped either.



Unparalleled growth
So much for the bad news. How big the aforementioned obstacles may be, they fail to throw a shadow on China’s potential for growth. Its prospects in terms of organic growth are still unparalleled. The dairy market, for example, is heavily underdeveloped. The small Australian food distributor Frontier Foods jumped into the previously non-existing Chinese cheese market and seems to be doing very well.

Via Wal-Mart and—later on—Carrefour, Frontier got a break to gain distribution. From then on, sales went up, not only because the product was available, but also because Chinese consumers became increasingly familiar with cheese thanks to KFC and McDonald’s.

Benoit Rossignol, director of Shiyao Investment—active in foreign investment in the Chinese food and retail market—says there are ample opportunities for Western players to differentiate themselves from price-aggressive competitors.

“In urban areas, there is an increasing demand for processed, convenience food (see Continued growth). Also, infant milk formula has become an opportunity for Western companies as a result of a recent fake baby milk scandal.”

Besides targeting certain niche markets, brand building has proven to be effective in some cases. Rossignol says, “Danone’s joint venture with Wahaha has become very successful by building a domestic brand using Danone’s technical and brand building expertise combined with the local market expertise of its Chinese partner.”

Future challenge
National brand building clearly poses a future challenge for foreign producers. Tom Stanley, director at KPMG Transactional Services in Hong Kong, says, “Brewing is a good example. China should be a tempting target, as beer is a popular drink throughout the country. However, there are hundreds of local and regional breweries. In practice it has proved to be extremely difficult to establish a national brand profile.”

Difficult or not, eventually foreign companies will increasingly have to go inland to build their national brands. According to Jacques Penrihin, principal at the Greater China office of McKinsey & Company, most foreign companies are neglecting 90%—them equivalent of 700 million people—of the market.

In some categories, such as personal care, several companies already did. Interestingly, their marketing tactics differed from the one they used in the urbanized areas around Beijing, Shanghai and Guangzhou.

Instead of focusing on the ‘Western heritage’, quality and innovation, companies concentrated on educating less savvy consumers on the benefits of the product. Of course, this approach only works if consumers are totally unaware of certain products. In the case of shampoo, they were because most Chinese consumers used to wash their hair with soap.

Protectionism
The point is: how to go about going inland? Rossignol recommends the acquisition route. “Local companies have the channels already in place. This will allow local businesses in these regions to see your products, and if they do well you will start being contacted by other retailers who will want your products on their shelves.”

According to Rossignol, several multinationals have lost lots of money by investing too quickly and too early (see Three waves). On the other hand, there have been companies which have been successful with moderate investment.”

Rossignol agrees with Penrihin to the extent that companies need to go inland. However, he would advise companies to focus on a certain region first. Generally, it takes time to build essential relationships, which are needed to get your products to consumers.

“In the near future, it will be easier to serve second, third or even fourth-tier cities, as foreign retail chains are expanding rapidly into the China. Furthermore, it seems that the Chinese government— since China’s accession to the WTO in 2001—is trying to develop the rural areas and remove protectionist measures from the provinces. These are encouraging signs for both domestic and foreign producers.”

Distribution Within ten years, research agency IGD expects that China’s road network will be up to Western standards. At the moment, China’s road network measures 1.85 million kilometers, of which 34,000 kilometers are motorway. Ultimately, the road network will be four million kilometers long (in 2050). Recent improvements in the connections between primary and secondary cities have been nullified in some cases due to excessive overloading of freight trucks. By licensing drivers according to the weight of their load instead of the size of their truck, the government tries to prevent further damage. The Chinese government also wants to improve its rail network by investing $29 million in the next six years.

Sources:
Food Processing in China, USDA (2005)
Retailing in China, IGD (2005)
Consumer Markets in China – the real deal?, KPMG (2005)
China Economic Quarterly
Our thanks to our sister publication Food Engineering & Ingredients for this article.