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I was quoted recently in an article in the New York Times on the growing demand of direct sales in China.  The article is very well done and I highly recommend anything that David Barboza writes on China … the man knows his stuff about China and he really does his homework.  One of our Five themes for China in 2010 and Beyond is “Distribution” and the direct-sales model is a very interesting one for China so I wanted to add a couple more comments here.

For those not familiar with it, “direct sales” is when individuals are recruited by a company to sell their products directly to consumers who are, typically, their friends and family.  There are many well-known companies that have used this model such as Mary Kay, Amway and Avon (those of a certain age will remember the old commercials in the U.S. whose tagline was “Ding-dong, Avon Lady calling!”).  As David’s article notes, direct sales have not always had smooth sailing in China as the government has been wary of allowing individuals to start up their own businesses (because, as we know, once people have money-power they want all sorts of other power).  I think that the combination of entrepreneurial sellers and adventuresome consumers are fertile ground in China for direct selling business models for two main reasons: first, direct-selling can leverage relationship-based sales which have a long history and solid cultural foundation in China; and secondly, direct-selling goes around the modern sales channels in China which, although growing in strength, are still very immature and often very difficult to work with.

One of the main reasons that China’s distribution networks have been so fragmented is that they have been based on guanxi or relationships which are simultaneously personal and professional.  In a traditional distribution model, this guanxi holds you back because you are limited in they amount of personal relationships that you can maintain at any one time.  In other words, if my hometown is in Wuhan, all of my guanxi will likely be from that place because I grew up with many of these people, our families know each other, we went to school together, etc.  However, if I try to expand that guanxi network out to, say, a city like Chengdu (probably over 1,000 km away from Wuhan) it will not be possible to develop the same depth of relationships in that region.

Historically, sales in China have been based on this guanxi … I get the sale, not necessarily because I have the best price or the best quality product, but because I have good guanxi with you.  However, this is rapidly changing in China: while good guanxi is a necessary condition to successful sales, it is by no means a sufficient one — I now have to bring good products to the market at good prices.  And for most industrial and consumer products companies, this is a good thing because it means that they can develop more “professional” distribution channels and get a broader sales footprint in China.

So let’s go back to the direct-sales model … this is a model that leverages (and even celebrates) guanxi-based sales.  Sales most often are made to friends and family (or the friends and family of other friends) and, while these product suppliers are certainly concerned to bring good quality products to market, I would argue that they are relying even more on the strength of their sales teams’ guanxi in their local area.  The strength of the direct-selling model is that it goes with the flow of traditional Chinese culture, not against it, by making each sale personal.  And all you have to do is multiply the large number of people in China by their growing disposable income and you understand why executives at companies such as Mary Kay, Amway and Avon are having a hard time controlling their excessive drooling.

The second reason why I think that the direct sales model will have some legs in China is that it goes around the typical sales channels for consumer products: retail stores.  This is a topic too large for one blog post but suffice it to say that China is in the midst of a sea-change in its retail channels, moving from a “traditional” model — dominated by mom-and-pop stores and small specialty stores — to a “modern” model dominated by the larger hypermarkets, “Big Box” and grocery chains.  If you look at China as a whole, a slight majority of consumer products are sold through traditional channels; however, the growth is in the modern channels and particularly in the so-called “hypermarkets”, chains such as Wal-Mart, Carrefour, Rt-Mart, etc.

Initially, consumer products companies were excited about this change … selling to many thousands of traditional outlets is much more difficult than selling to fewer (and larger) modern chains.  However, what everyone is realizing is that these modern chains, while good looking on the outside, are often very difficult to work with simply because they are so big and wield so much power.  The cost of doing business with them — what consumer products companies call “trading terms” — are often quite high in China compared to the rest of the world so while consumer products companies are often happy with the volume that moves through modern channels, they are not as happy with the margins (and multinational consumer products companies are ALL about the margins!).  These companies are often finding that the hypermarkets are not all that good at merchandising and marketing themselves so consumer products companies often feel that they end up paying a lot in terms of marketing fees and not getting all that much for it.

However, the direct-sales model does an end-run around these channels and goes directly to the consumer.  The only marketing fees are the commissions to the sellers so, theoretically, both the margins and the volumes can be quite high.  Consumer products companies don’t have to deal with the retail stores nor do they have to work with distributors to those stores (a topic for another blogpost). In our work with consumer products companies, some of them — and some big names too — have secretly asked about direct-selling and whether or not they could do it.  To date, none of them have but that doesn’t mean that they are not thinking about it.

Now this direct-selling model is not all beer and skittles and in his New York Times article, David Barboza identifies some of the challenges that companies such as Mary Kay are facing (for one, direct sales companies are required to open their own “brick and mortar” retail stores through which to do they actual distribution of product).  Suffice it to say, there is no magic bullet in China retail … we are in the midst of a mini-revolution in China retail and all players — retailers, product companies, distributors and consumers — are changing faster than we can keep up with them.  However, given the sheer size and potential on the China consumer market, everyone is dumping massive amounts of investment and are exhibiting as much patience as they can.  Keep your eye on the direct-sales model in China … we could see it expand beyond the companies we typically associate it with and move into areas we never thought possible.

This entry was posted on Saturday, January 2nd, 2010 at 4:48 pm and is filed under Technomic Asia news, consumer goods, culture, distribution, government, guanxi, podcast, retail, strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.