P&G China

Why China’s Retail Prices Are Surprisingly High

Ming Dynasty porcelain detail from China First CApital blog post

Making things in China is cheap. Buying things in China is not.

People living elsewhere, or ones like me who move here, will be rather surprised  to find out how expensive prices are for many of the more familiar brand-name products on sale in China. At current exchange rate of 6.78 renminbi to the dollar, many goods and services in China are sold at prices similar to the US.

Years ago, the Economist came up with their “Big Mac Index” as a way to measure real exchange rates. In their most recent survey, the renminbi looks 48% undervalued, because a Big Mac costs $1.95 in China, compared to $3.73 in the USA.


Big Mac Index
Source: The Economist

Of course, those prices tell only part of the story. Chinese wages are about 1/15th America’s. So, while it takes an average working American about ten minutes to earn the money to buy a Big Mac, in China, a reasonably well-paid office worker would need to toil about about four times as long to earn the Rmb 13 needed to buy a Big Mac. By this measure, the price of a Big Mac in China, to truly equal the price in the US, should be about 33 cents, and therefore the exchange rate should be over Rmb35 to the dollar.

Of course, the renminbi is never going to get that low. In fact, the overwhelming likelihood is that renminbi will get much stronger than the current rate of 6.78 to the dollar. Upward pressure comes from China’s $2 trillion in foreign exchange reserves and large balance of trade surplus with the US. As the renminbi rises in value, the prices of many goods in China will become even higher, when translated into dollars, than those in the US.

How expensive are things in China? To find out, I did a little comparison shopping at the Wal-Mart closest to my office in Shenzhen. As in the US, Wal-Mart in China is highly successful, and got that way by offering “low everyday prices”. Considering the big gap in income levels between US and China, it would be a fair assumption that prices at Wal-Mart in China would be appreciably lower than those at Wal-Mart in the US.

But, that assumption would be wrong, for the most part. Here’s a rundown of prices on some popular branded products at my local Shenzhen Wal-Mart — prices below are in renminbi and current dollar equivalent at prevailing exchange rate. Quite a few are Procter & Gamble products. P&G are very strong in China, and its products are often market leaders. As in the US, P&G enjoys a close relationship with Wal-Mart.

 

PricesSource: Peter’s Shopping

 

A few days after my visit to Wal-Mart in Shenzhen I flew to New York on business. In between meetings, I did some comparison shopping. 

Wal-Mart is the largest retailer in the US, but does not have any stores in New York. One reason is New York City’s unfriendly labor laws that would make it hard for Wal-Mart to operate in New York without unionized workers. Instead, I checked prices at local Food Emporium supermarket, Walgreens and CVS

While there are some pretty good deals in China, for example Heinz Ketchup and Coke, most things on the list are in line with prices in the US.  In other words, they do not reflect the vast differences in average earnings and therefore purchasing power.

Chinese workers manufacture wholesale, but buy retail.

Prices in China are high, in part, because there is a VAT of 13% on most things. More important, retailing in China is not nearly as efficient as it is in the US. While Wal-Mart is successful in China, it doesn’t enjoy anything like the market share it does in the US. Smaller, but my guess is, far more profitable. Wal-Mart faces very limited low-price competition in China. Most stores are of the Mom-and-Pop variety, which keeps overall prices high. Urban real estate is also expensive, and that also has an underlying impact on consumer prices.

In China, it’s easier to make money selling than manufacturing. Retail margins are higher and less squeezed than they are in the US. This will likely be true for many years to come. For Chinese consumers, especially the +40% who live in cities, they will likely continue to pay prices on par with those in the US, while earning appreciably less.


China’s Brand New Brand Names

Ming Jiajing jar from China First Capital blog post

1837. That’s when the first and still grandest of all consumer brand companies got its start.  Procter & Gamble started off selling soap and candles, then in 1879, introduced its first major branded product, Ivory soap, which quickly became the leading soap brand in the US. P&G then gradually, over the next 130 years, added other brands that became market leaders, including Tide, Crest, Pampers, Gillette, Olay, Head & Shoulders

This same slow-and-steady pace characterizes most other well-known consumer brand companies, including: Unilever, Coca-Cola, McDonalds, Mercedes-Benz, Gucci, Tiffany, Nike, Hershey, Crayola (http://www.chinafirstcapital.com/blog/archives/927), etc. 

The lesson: building brands takes time. Lots and lots of time. 

Except, that is, in China. Here, brands go from drawing board to market dominance in a matter of a few years, or less. The reason? Like so much else in China, economic and social change occurs so rapidly that time seems compressed. Three years of economic growth in China is faster than a generation’s economic growth elsewhere. No major economy in modern times has grown as fast, for as long, as China has over the last 30 years.

gdp

 The other reason, peculiar to China, is that there were few brands of any kind before the 1980s. Back then, a stolid proletarian China had a depressingly small number of equally stolid proletarian brands. Many have since disappeared. Those that are still around have often been overwhelmed into irrelevance by newer Chinese brands, or ones imported from abroad.

Good examples of this are Flying Pigeon bicycles and Bee & Flower soap. They were once near-monopolies in China, during Mao’s time. Today, they are bare remnants of their former, dominant selves. Neither has more than a 1% market share, if that. It’s hard to find any other examples outside China during the last 25 years of once-dominant brands losing so much market share so quickly. 

In the US and Europe, older brands often have cache. In China, they are toxic, for the most part, because they are the products of an era of scarcity and little to no consumer choice. So, the tens of thousands of Chinese consumer brands created over the last 25 years entered a market with few, if any, well-established incumbents. A few foreign brands have also done well in China’s mass market over this time: P&G has a great business here with Crest, Tide, Olay, Pantene. Other winners include junk food giants McDonalds & KFC, along with Coca-Cola, Nokia, Apple, Nike, Marlboro, Loreal.

But, in many cases, new Chinese brands have fought and won against competition from well-known imports. Protectionist trade rules have played some part in this, of course. But, a lot of the credit really belongs to smart Chinese entrepreneurs. Thanks to them, China’s consumer market has gone from brand-less to branded in less than a generation.

P&G’s kingpins, like Crest, Pantene and Tide, face a proliferation of Chinese competitors, priced both lower and higher than the global brands. In many other product markets, Chinese brands stand alone, including tissues and toilet paper (sold here in bulky ten-roll packs), bed linen, men’s and women’s underwear, and most food products.

Overall, there are few dominant brands with market shares large enough to discourage new competitors. In fact, new brands arrive all the time. In evolutionary terms, China is in the middle of a kind of Cambrian Explosion, with the rapid appearance of all kinds of new brands. Inevitably, the huge number of brands will shrink, as winners emerge, and has-beens die out. This process took decades in the US and Europe. It will almost certainly happen far more quickly in China. 

One reason for the especially rapid pace: lots of capital is now available to create and support new brands. Why? There is so much to be gained for any company that establishes a dominant brand in China. China will soon have the largest domestic market in the world. Grabbing a few points of market share in China will often equate to billions of dollars in revenue over the next five to ten years. 

In many of the most promising consumer markets, no brand has even emerged yet, with national scope and distribution. Here, smart entrepreneurs can build a brand in fertile virgin turf, rather than trying to force their way into an already crowded patch. If done right, you can turn a new brand into a billion-dollar household name in a short-time. 

I see this process very clearly with one of our clients. It’s still quite a ways from being that billion-dollar colossus, but it has a real potential to become one. The entrepreneur spotted a huge market opportunity five years ago, to create a brand to sell designer accessories to Chinese women from 20 to 35 years-old.

His key insight: the process of urbanization in China is creating an enormous group of working women in this age bracket, with the spare income to spend on not-too-expensive, but well-designed earrings, bracelets, necklaces, sunglasses. 

His business is now growing very fast, with over 100 stores in most of China’s major cities. Sales should double in 2010 to about $50mn, and keep doubling every 18 months for a long time to come. The best part: he faces no real competition, and so every day, his brand grows more and more known, and so less and less vulnerable to whatever competitors may one day come along. My guess is that this brand will be one of the quickest new consumer product companies in Chinese history to reach Rmb 1 billion in sales. 

Like many of the best entrepreneurs, this one makes it look very easy. It isn’t. He takes hands-on responsibility for the four key disciplines needed to build and sustain the brand: marketing, design, management and manufacturing.

That’s the other part about brand-building in China: it not only happens fast, it often happens inside smaller founder-run companies without the input of “specialists” or ad agencies.  I don’t know how many people in China have studied product marketing in school, but my guess is not many.