New Opportunities Abound in China's 4th-6th Tier Towns

Many of the best opportunities for growth in China for foreign companies involve moving into the country's heartland and away from the modern mega-cities along the eastern coast. The government’s nearly $600 billion stimulus program launched earlier this year is targeting the country’s interior and is expected to accelerate this trend.

A recent study from Ogilvy China suggests ways in which companies can tap into the opportunity offered by the government's stimulus package, in a significant part of the nation where consumer cultures and retail landscapes vary markedly from that in 2nd-3rd tier cities and leading cities.

To enjoy sustainable profits in China many companies need to tailor their products and services to the low end market. Dan Harris, a Seattle-based lawyer and author of the popular China Law Blog, says there are really two markets in China. "China's high end market is typically way way smaller than the low end market,” wrote Harris in April. "The high end market seeks out Western made goods at typically Western country prices. Prices in the low end market might be as little as 25% of those in the high end market."

Harris cites the car market as an example with BMW, Buick, Honda (HMC), and Volvo (VOLVY.PK) and various other Western manufacturers making up the high end and QQ, Chery, and various other Chinese auto manufacturers at the low end. Ogilvy says brands should embrace strategies formulated on local insights and market conditions to connect with small town consumers.

The Ogilvy study entitled China Beyond says China's 4th-6th tier towns, which account for 37% of China's population, have notably different consumer cultures and retail landscapes not only from the major metropolises of Beijing, Shanghai and Guangzhou but also from 2nd-3rd tier cities, such as Nanjing and Suzhou. Brands must recognize and take advantage of diversity and local characteristics to deliver authentic products and experiences.

Companies can also take advantage of ongoing urbanization. About 600 million Chinese lived in cities at the beginning of 2008, yet that represented only 45 percent of the population, compared with more than 80 percent in the United States, so China's cities are likely to grow considerably, says McKinsey Global Institute. It projects that by 2025 China's cities will add 325 million more people, including about 230 million migrants.

The good news is consumers in low tier markets have a stronger capacity to spend money than most companies would have estimated. "This demonstrates the huge market potential in lower tier cities. With the government stimulus package directed at small town and rural China, it is expected that these consumers will dip into their savings and give China's economy a helping hand. But for them to do so, companies need to understand what drives their needs, aspirations, and ultimately purchase decisions," says Shenan Chuang, CEO of Ogilvy & Mather Group China.

There are huge opportunities for consumer durables and home furnishing companies to help people decorate or renovate their homes. For instance, small town living is typified by mostly unkempt, disorganized homes so home building brands might collaborate with consumer durable marketers and media companies to sell the concept of home makeovers, says the study.

The study makes the following points.

• With the influx of migrant labor, communities have established new rules of engagement and trust. The "web of favors" replaces the time-honored, high-trust relationship in small communities.
• The pace of development is amplified by the anxious youth and their relationship with technology. Most young people, though optimistic about the future, do not know how to use the Internet for information, education and better opportunities.
• Families in small towns usually have two children, and their sphere of influence is arguably larger than that of the pampered big city child. This social reality offers many opportunities for marketers to become more relevant to consumers by helping to create a better future for children.
• Nationalism is a touchy, inflammatory topic that easily unifies consumer behavior in low tier cities. International companies need to be sensitive enough not to antagonize local customers.
• China's low tier cities represent the other end of globalization. It produces fresh foods and raw materials as much as it produces new ideas. It is at this level where cultural diversity and local distinctiveness can be teased out and used as resources.

A vast opportunity exists for companies that can tap into local and regional psyches and lifestyles. Many Western businesses run the risk of ignoring China’s local market at their peril.

"Whether a company chooses to try and compete with Chinese companies in the country's low-end market or not, it should clearly understand that this market exists, and it should have a clear view as to how its future development may threaten the profitability and future potential of its existing business in the high end," says Jack Perkowski of Managing the Dragon blog. “Make no mistake about it: it will have a major impact.”

Disclosure: No positions

Comments

[HaavBline:]

Good article.

Many China observers, even experienced ones, failed to properely account for the customer market potential of China's smaller cities and consistently underestimate the growth potential there. This article should help those doubters who are still missing out on the huge opportunities.

Jul 24 09:19 PM

[Tony Daltorio:]

Great article! Wall Street is still years behind as far as what is going on in China. They only look at Shangai and other large eastern coastal cities. The real growth in China is in the smaller cities inland.

Jul 25 01:48 PM

[fleeing omega:]

It would be nice to know which cities are considered 4th-6th tier. You pointed out a few that aren't. The original article didn't have more than you posted. I am guessing Tianjin, Qingdao, Xiamen are too developed to be on this list? Where would Chengdu, Changsha, Guilin, Dalian, Xian fit in to this scheme? (some being larger, some more developed). It would be nice to know more specifically what you are talking about.

Jul 26 01:48 AM

[James Lewis:]

Setting up distribution in the lower tier cities is very difficult. Also lets be clear that the big chinese brands already have their distribution channels set up and are plugging Chinese goods.

Competing on this level is very hard, very very hard.
Please note local merchants do not pay proper taxes, where as foreign companies generally do. This 20% margin difference makes it ever harder. The added cost of doing business almost always wipes out any gain forign companies can make in areas such as innovation, marketing, business efficiency.

Foreign companies can not make money in many areas becuse the playing field is not flat

Jul 26 11:11 AM

[nmelendez:]

So competition in the US is fair? Yea right, and i got a bridge in Brooklyn for sale.


On Jul 26 11:11 AM James Lewis wrote:

> Setting up distribution in the lower tier cities is very difficult.
> Also lets be clear that the big chinese brands already have their
> distribution channels set up and are plugging Chinese goods.
>
> Competing on this level is very hard, very very hard.
> Please note local merchants do not pay proper taxes, where as foreign
> companies generally do. This 20% margin difference makes it ever
> harder. The added cost of doing business almost always wipes out
> any gain forign companies can make in areas such as innovation, marketing,
> business efficiency.
>
> Foreign companies can not make money in many areas becuse the playing
> field is not flat

Aug 07 09:44 PM