We are very active in the fashion/accessory/luxury market in China. For a couple of years now I have been telling anyone who will listen that this is the hottest apparel market in the world. Well, we now have this A.T. Kearney report to back up what I have been talking about.

Hat tip to Mr. Robert Shecterle for the summary. To which I would add that in addition to the sales channels mentioned, we found that multi-brand stores, multi-brand boutiques and franchises are starting to creep their way into increasing importance in China. The dominance of the distributor, mall, department store and/or stand alone store model is starting to erode. Add to this the growing importance of e-commerce and concept stores. Part two of this post will discuss these new channels.

There is an an interesting top ten market list at the end as well.

China is now the most attractive emerging market for apparel retailers, according to A. T. Kearney’s latest Apparel Index, and already, several brands have aggressively entered the market.

PHV Apparel Group (perhaps best known for its signature brand, Izod) plans to open 3,000 stores in China over the next five years. Likewise, Italian retailer RDM has invested $910 million to develop five luxury outlet centers there, and Gap, Inc. opened stores in Beijing and Shanghai late last year.

According to A. T. Kearney, China’s growing middle class is expanding its buying behaviors beyond traditional venues.

“Retail formats in China are diversifying beyond traditional department stores. Chinese consumers are beginning to shop at venues such as hyper markets, specialty stores, outlets, discount stores and online,” Hana Ben-Shabat, a partner with A.T. Kearney and co-leader of the 2011 Apparel Index study, said.

The United Arab Emirates ranked second in the 2011 Apparel Index, driven by a population with a high disposable income and immense fashion consciousness. In addition, as A. T. Kearney points out, the expatriate populace and tourism also drive consumption in this market. Plus, the UAE is both a regional commerce center in the Middle East and a preferred market for entering the Middle East, as well as for testing new products and retail formats.

The Retail Apparel Index is calculated on a scale from 0 to 100. It includes analysis of the clothing market attractiveness (60 percent), levels of retail development (20 percent) and country risk (20 percent). Country risk indicators include political and financial risk, business readiness and business cost of crime, terrorism and corruption.

Here are the 2011 Apparel Index “top ten,” along with each country’s overall score:

1. China 61.4
2. UAE 58.9
3. Kuwait 48.6
4. Russia 46.4
5. Saudi Arabia 43.9
6. India 42.0
7. Brazil 40.1
8. Turkey 37.4
9. Vietnam 37.3
10. Chile 36.9

A full copy of the report is available at www.atkearney.com/grdi.

It may take some getting used to, but China’s luxury market is making its way into “affordable” luxury items. This trend to meet the needs of the growing middle and upper middle class consumers is creating opportunities for a larger number of brands, domestic and foreign.

We are working with a women’s fashion accessory company to launch a product line this year and the early research shows some surprising aspects of  the affordable luxury brand purchasing among China’s consumers. Chinese buy brands for similar reasons as consumers from other economies, however, there is a sense of a dynamic in this market, compared to the same group of luxury brand consumers in other markets.

My analysis of China’s increasing aspirational consumer is setting up a niche market that is under the top price points, but significantly above the price of average products.  This is driven by the rise in income and employment status of China’s growing middle class who want to buy quality, to convey an appearance of luxury, and who desire to portray being a “global citizen” by purchasing international products.   In some cases, this category of consumer wants to blaze a new path by purchasing non-traditional, high quality products which is creating opportunities for small and midsize foreign companies to jump into China.

This is my other car

Need proof? Get this, Lamborghini contemplates a new “everyday” model. CEO Stephan Winkelmann, told the Reuters Global Luxury and Fashion Summit that increased sales in China are tempting the high-end auto designer to consider an “everyday” model for its current  product line.

A key indicator in any market is to follow the money. China luxury brand categories are no exception to this rule. The line up for Initial Public Offerings and listings on the Hong Kong stock market would delight the most vigorous name dropper, Prada, Coach, L’Occtaine among others. Luxury China jeweler Chow Tai Fook is creating a buzz as its IPO is on the ears and lips of investors.

Our suggestions to those considering an entry into China’s hot fashion industry:

1. Personnel must be here on the ground, China is not a “handle remotely” market
2. Test pricing strategy as the “Affordable” luxury market is new for all parties, consumer, distributor, and manufacturer alike
3. Public Relations in country can help build brand and create excitement around product launch
4. Distribution options while slim a couple of years ago are changing rapidly, be flexible even if you are committed to building your own storefronts.

If you have questions or are a member of the media, contact me at mzakkour AT tompkinsinc DOT com

China imposes “Harmony” tax on foreign companies

Beijing declares talk of Inflation a “thought crime”

When in doubt, blame foreigners

China fines Unilever $300,000 for talk of possible price increases

The last one is the actual headline but the first three could have been the subheads. Inflation has risen 5.4% in China this year and keeping prices under control is a top priority for 2011. Patrick Chovanec, an economics professor at Tsinghua University in Beijing said today that China’s leaders are “trying to put out fires and the fire of the day is inflation…” If you were wondering, yes, the government can impose these fines. The only constant in China is finding out how much you don’t know, no matter how long you have been here.

Under China’s “Price Law” companies can be fined for “spreading rumors about price increases.” Who knew? So Unilever, which only suggested verbally that they might, possibly, are considering, about to mull, perhaps dreamed about, could, may, raise prices to deal with rising raw material and labor costs, brings down the “hammer of harmony” upon themselves. And they were thus smote: “Severe punishment was meted out this time to break ugly habits and build new rules, said the National Development and Reform Commission, warning other firms to “absorb the lesson.”

I urge all regional heads, C-suite suits, brand managers and companies selling products in China to take note.
This is a blunt proclamation aimed at keeping a “Harmonious society” – China-speak for keeping the people happy, healthy, fed and paid so that protests and social unrest leading to a questioning of Party rule do not develop. Right now inflation is the threat and your company needs to be aware of the social and political context in which pricing your products takes place.

To be clear: Inflation threatens harmony, social unrest threatens the government, and that could be a threat to your business in China. It is unlikely that these fines will become a major trend. Enforcement is difficult and the PR message would be bad for China Inc. (although that doesn’t always stop cases of “tin ear syndrome” on the Mainland).*  Nonetheless it is an example of why companies in China need to be constantly evaluating the political as well as social trends that impact business.

In the end China needs to solve the real causes of inflation:

• -Oversupply of money post-2009 stimulus
• -Rising cost of raw materials and commodities
• -Continued Urbanization
• -Need for further Yuan appreciation (note this is happening now and the RMB hit an all-time high against the dollar as I am writing this)

Make no mistake, the Government has problems that are in many ways common with other countries but are uniquely large in scale and cultural import.  They are usually adept at navigating dark waters.  As short and long term programs and policies are put in place to deal with the big picture problems it would still be wise to take stock of where your company, products and prices fit in. Hell, if I knew I wouldn’t sound so cynical I might even suggest, if I were your consultant, that you create messaging/take actions to address this issue and work it to your advantage. After all, working with government initiatives and goals in mind , and never against them, is a sure path to…Harmony.

Updated: Tuesday, May 10, 2:13 New York Time

I just read my good friend Dan Harris’ post at the China Law Blog on the same topic Unilever fined for mentioning the I (inflation) word. I recommend his insightful post about what it means for you.

*H/T to JF

So when our research manager, Frank Tsai, came to me and said that he could see some value in a review of the week’s news on China, I admit that I was a bit skeptical. It seemed to me like we were just anthologizing stuff already out there.  But as he kept talking and showing me some material, I came around … there is a TON of good writing on China and, while it is impossible to take it all in, it is important to try.  So we are going to try an experiment … every week, we’ll highlight some of the things that interest us about the news on China, adding comments where we feel we can add something or just setting it out there for you to take in.  We won’t stop the original stuff … that’s our bread and butter (and besides, its cheaper than therapy for us) … but let’s see how this goes.  Drop us a line and let us know what you think and/or clue us in to things that you think we should be paying attention to.

OK, here goes…

Living in a Bubble?

When your Chinese friends are making six figure (USD) salaries, and they say they don’t FEEL rich, even though the cost of living is almost invariably much lower in China, you know something is odd.  They feel that way because housing costs in Shanghai are 20 to 50 times annual income for the typical ($10,000/year) worker, and the better homes that rich Chinese executives want to buy are still 10 to 20 times annual income.   According to the China Daily, real estate prices rose at their fastest rate in two years in February, going up 10.7% year-on-year in 70 major cities, and undoubtedly even faster in major cities like Shanghai and Beijing.  Housing and housing-related purchases, according to the Global Times, now account for 40% of consumer spending, and have accounted for 20% of GDP since 1998.  While the government has recognized the risk that rising asset prices pose for inflation and social stability, and has signaled measures to curb the property market, some investment banks like UBS are, apparently, still bullish on Chinese property.  Needless to say, the continuing boom in housing-related purchases is great news for many foreign companies – from an IKEA, to home appliances, to decoration services, to home water purifiers.  However, we all get the feeling that “something” is out there and, at least among average people who have become “overnight millionaires” just by owning homes in Shanghai, there does seem to be the ominous feeling that values can’t keep rising.

Working for a Living

Years ago, the rallying cry for multinational participation in China was “cheap labor!!”.  Well, while labor costs in China are still much lower than North America or Western Europe, we are seeing some changes here as well.   In recent months, factory wages have risen by about 20 percent, as many migrant workers have gone home for the Chinese New Year and decided to stay home, having found better (and often less arduous) jobs in their hometowns.  According to the China Economic Review, many factories have had to lure back workers with substantial raises and that the average wage for a migrant worker in Shenzhen is now about $200/month.  Despite fears of a labor shortage at the low end, however, college graduates at the higher end are facing dimmer prospects, as detailed in pieces in both the LA Times and the New York Times.  So it seems that demand in the labor market is becoming curiously U-shaped, with factory workers getting raises and the experienced managers seeing their wages double and triple in just a few years, while recent graduates suffer on subsistence pay, even at good companies.

Gloom and Doom

Year-end predictions are lots of fun … you get to talk eloquently about what just happened (and drop a few “I-told-you-so’s” in if you can) and then go all Nostradamus and predict a gloomy future.  If you are right, kudos to you.  If you are wrong, that’s OK because it means the gloom-and-doom didn’t happen and everyone is basically happy.  This could be the case in an article in the New York Times that came out last December that highlighted the three greatest dangers that could derail the Chinese economy are inflation, protectionism, and inequality.  Let’s see how they’ve been doing so far …

• Chinese economists have been sanguine about Febuary’s 2.7 increase in the CPI, and policy shifts are unlikely in the near-term.  However, we’ve seen instances where China moves pretty quickly against inflation should the need arise so that might be the source of their comfort.
• Pressure for protectionism against China could rise, however, in light of China’s 46% export increase in February and slim chances that the government will let the RMB will appreciate.
• Growing inequality is reflected in the growing ranks of Chinese billionaires, and in a sign that the government is concerned about inequality, it recently capped the compensation of bank executives in line with similar measures in the West.

Hmmm … seems they’re doing pretty well so far, but the year is still young.  Stay tuned for more.

One of our themes for 2010 here at the China Business Blog and Podcast is “acquisitions”.  A typical market sector in China is very fragmented and very crowded – there are many players working in their own local areas.  From automotive, to healthcare to consumer products … they are all this way.  Both foreign and local companies will be looking to strengthen their positions in these markets by acquiring smaller players, bringing products, brands and distribution together to gain scale and more power in the market.

In early 2009, the global economic crisis knocked the wind out of the M&A market all over the world, and here in China, it was no exception.  Transaction volume fell off significantly as companies hunkered down to wait out the storm.  Well, though for many individuals around the world, the storm is still blowing, for companies and investors here in China, it is prime time to move … they have motivation to grow and cash to invest.  The challenge, as we will explore today, is managing risk.

Here at Technomic Asia, we have strengthened our M&A practice to include end-to-end transaction services and have brought in to the Technomic family one of the preeminent deal guys in China, Dr. Kim Woodard.  When Kim joined us late last year, we started a Podcast series on M&A in China.  Today we are going to continue that series as Kim and I talk about managing risk in China M&A.  And we start off discussing a very shocking statistic …

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.

In our recent Podcast series, we have been talking with Bill Powell, senior writer for Time and Fortune magazines, based in Shanghai.  In the last Podcast, we got into, what I thought, was a VERY interesting discussion about the uniqueness of what is going on in China these days.  Literally, what we are seeing in China is unprecedented … never before has an economy (and a society) grown and changed so much in such a short period of time.  Understanding it, let alone predicting it, is very difficult and we are all, in a sense, working without a script.  We talked earlier about what the U.S. and other Western economies could learn from China … to wrap up our conversation, I started by asking Bill what he thought China could (and should) learn from the West …

But Wal-Mart is not necessarily cutting staff … they are “relocating” them.  This might not be such a big deal in the U.S. where white collar management in retail is somewhat used to being moved about like pawns on a national chess board (a friend of ours with Best Buy was relocated 5 times in 11 years).  But in China, this is a big deal.  The hukou system – whereby everyone has a city “residence permit” that gives them and their families access to cit services such as education – is still alive and well in China.  It used to be (10+ years ago) that the hukou system would keep people from moving at all because you could not get healthcare or education in a city in which you did not have your hukou.  Many of those restrictions, particularly for white collar workers, have been lifted.  A lot of people now living in the big cities (i.e. Beijing, Shanghai, Guangzhou) are not originally from here, but many of them sure hope to get their hukou here some day.  For instance, of the 20 people in our Shanghai office, only 6 are from Shanghai itself; the rest are wai di ren, or “outsiders”, in a polite way of speaking.

So when Wal-Mart says they are going to relocate people, this – in and of itself – is not a shocking thing.  Lots of people in modern China are from “somewhere else”.  The problem is where Wal-Mart will likely relocate them to.  The vast majority of Wal-Mart’s recently-opened stores are not in the big cities.  Ammend that: they ARE in big cities, just not THE big cities of Shanghai, Beijing and Guangzhou.  They are in smaller cities like Wuhu (in Anhui province with 2.3 million people) or in Maoming, a prefecture-level city in southwestern Guangdong province with a population of “only” 6.8 million.

“There are no layoffs,” said Jonathan Dong, a spokesman for Wal-Mart China. “If someone wants to go somewhere else [outside Wal-Mart], that is their decision.”  Right.  The “choice” they are offered will be moving to Maoming and keep your job or stay in Shanghai and lose it.  If true, it is an ingenious play…Wal-Mart is able to stay within the strict confines of the labor law that makes it difficult to let workers go and still effectively reduce their workforce.  If my way IS the highway, the choice is easy.

So when the Chinese government wants to encourage consumer spending, they are up against some interesting challenges.  Remember that only 34% of China’s GDP is supplied by consumer spending (in the United States of Easy Credit, it is over 70%).  China is a land of savers, of people who don’t trust the social security network and figure they will need to foot the bill for their parents’ and their own retirement.  Kinda limits your spending at present when you are your 401(K)  for the future – but I bet these personal 401(K) did better than mine last year!

Last week, one of my senior managers and I had lunch with a professor at a local business school whose expertise is in automotive.  We were talking about the dismal state of the car market in China where sales have dropped precipitously over the go-go years in recent history.  We pondered when and how the market could come back and, as with all consumer purchases, the conversation quickly turned to price.

As we discussed the importance of price, my senior manager made a very good point.  She said, “You know, in the West, you have a price in your minds that you are willing to pay and, if you can find it, you buy it.  But in China, our price comparisons are always against our friends and neighbors and we are always afraid that we will pay more than others will.”  In other words, in the West, something is a good price if it meets our own expectations; in China the price is good if it beats what my neighbor just paid.  Suddenly, it made sense to me – I thought that, when people ask how much I paid for something, they are just being nosy (like when they ask how old you are, what your salary is or how much you weigh!), but really, they are gathering market intelligence.

So the logical result of this intra-societal comparison shopping is that when prices are falling, everyone in China stops buying because they are waiting for the market to hit rock-bottom.  Everyone’s Pay-dar is on the Super Sensitive setting and the rumor mill runs rampant with pricing alerts.  We are seeing this, in particular, with the big-ticket items such as cars and real estate.  In the West, the auto market stinks because people can’t get financing.  In China, they don’t need financing because everyone pays cash – but what they can’t find is the confidence that they are paying “The Lowest Price.”

That said, the China retail market is doing OK, thank you very much.  Reports say that China retail sales reached RMB 290 bln (US$ 42.6 bln) during the Spring Festival Holiday this year.  It was also just announced that retail sales in Shanghai reached RMB 453.7 bln (US$ 66.7 bln).  Both of these figures are double digit growth over the previous year – again, compare that to ANY other part of the world at this time and China is a superstar.

But the lift off point is still some ways out.  The indicators will be rising Consumer Price Indices, an improving stock market and rising (or at least stable) housing prices.  Until then, look for China retail tactics that include massive sales and price-slashing.  People will likely be pretty open to buying something that says “NEW PRICE TODAY – DRASTICALLY REDUCED FROM YESTERDAY” because everyone knows someone who bought one yesterday!

U.S. economists and politicians are greeting this news with the appropriate amounts of hand wringing and brow-furrowing – depending on the economist, consumer spending represents around 70% of the total U.S. GDP so a drop in what people are buying in the U.S. means that absolute U.S. economic growth takes a big hit.  When people stop trying to keep up with the Joneses, the domino effect impacts the entire U.S. economy.

Although difficult to determine with any confidence at this point, while the Chinese economy is certainly slowing, consumer spending seems to be going along quite nicely.  I say this is difficult to determine for two reasons: #1, we are just coming out of the Chinese New Year holiday when Chinese citizens tend to spend like inebriated sailors on shore leave, thus skewing the data towards the positive; and #2, it is very difficult to determine the accuracy of ANY data here that might reflect poorly on the country’s leadership.  Reuters reports that consumer spending over the CNY holiday was up 13.8% from last year.  This is a drop in the growth of consumer spending from 19% last December, but still, it is a respectable number.  Let’s see what the numbers look like in February.

But we are not doing back flips here quite yet, mainly because consumer spending still does not represent as large a portion of GDP, estimated to be about 38% in China.  So while people here are still trying to keep up with the Wangs, this activity is not going to be as big of a boost to the Chinese economy as one would hope.

However, this might not hold true in Tier 3 & 4 cities in China – the “smaller” cities of only 1 million people.  We don’t have any good data available yet (if we ever will) but I would suggest that increasing consumer spending in the T3/4 cities in China might be a significant boost to the overall economy, more than it has been in the past.  Chinese commercial activity is still very local, with many manufacturers and brands having a very local impact.  National distribution is very difficult to do well and national brands, while certainly present, are not as strong in some of the T3/4 markets.  In these cities, people tend to buy local.  So if they are increasing their spending, then local manufacturers might be able to increase their production and maybe – just maybe – take up some of the slack we are seeing in soft employment figures, particularly in southern China.  This “trickle up” from T3/4 cities could be an important story in 2009.

More from the event description:

Rising oil and commodity prices. Changes in tax regulations. Inflated Chinese currency. With these recent changes in the Chinese landscape, just being in the game is no longer enough. To be successful, retail and consumer products companies need to take a strategic and financial approach to supplier relationship management and the operating environment.

Steve also will speak at the Council of Supply Chain Management Professionals 2008 Global Conference, also in October. Stay tuned for more information on that event.

The retail/consumer goods market in China is dramatically different than in the U.S. or anywhere else. The China Business Podcast’s own Kent Kedl and 13-year China vet Matt Cooper discuss some of the specifics of hitting this much sought-after market. Kent is co-author of “The China Ready Company,” and Matt been in China for years and has worked with companies such as Black & Decker, Sherwin Williams, Graco on China strategies.