Tap into China's Swelling Consumer Base

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by: Shaun Rein

This commentary originally appeared in Forbes

Treasury Secretary Timothy Geithner and Morgan Stanley Asia Chairman Stephen Roach have both been arguing that China needs to spur its domestic consumption by fixing its creaking health care and pension systems, so that older people start to spend. Will that really work?

The typical Chinese retiree has lived through a world war, a civil war, famine, the Cultural Revolution and political economic turmoil that make the current malaise smacking the U.S. look like almost nothing. Do you really think they will trust new policies so much that they stop saving and suddenly start spending? It is doubtful. Moreover, older Chinese have mostly missed out on the economic boom since 1978. They retired before the gold rush of the last few years, or they've been working in state-owned enterprises where the pay stays low. Even though their savings rate hovers around 60%, they don't have much money socked away.

Fixing China's health care and pension systems will not fuel domestic consumption in the short-term. What will be far more meaningful is unlocking the purchasing power of the 800 million Chinese who live in rural areas and third- and fourth-tier cities like Zhengzhou and Hefei. More than 100 Chinese cities have populations of more than a million.

The government is promoting consumption in those regions by giving rebates of 13% on purchases of household products and by building a network of small clinics to treat minor illnesses for low fees. Most encouragingly, plans are underway to let rural residents lease out their land, much as urban residents began to be able to do a decade ago, which unleashed China's urban retail boom. Many multinationals ignore these regions, thinking they are too poor and backward, but that is a mistake. Consumers there now have the income and the desire to buy foreign brands.

Aside from Chinese women in general (who I wrote about in "China's New Purchasing Powerhouse: Chinese Women"), residents of third- and fourth-tier cities are the most optimistic consumers in China. The world financial crisis has had little impact on them, as they have benefited from China's $586 billion stimulus package. Most of them work for domestic businesses that, unlike many foreign companies, have pledged not to reduce salaries or cut work hours.

The next great growth area for many multinationals will be selling to Chinese consumers in these regions, but the battleground will be fierce, for emerging domestic brands like the apparel company Li Ning and the home appliance maker Haier will also be in the fray. How can you sell to these consumers and stave off the competition? Here are a few key things to keep in mind.

First, consumers in third- and fourth-tier cities are not as price sensitive as many think, but they are very value conscious, and they want premium products. For instance, while the 13% rural rebate scheme has been wildly successful in driving demand for air conditioners, it has failed with TVs, because plasma and LCD screens weren't included, only old-fashioned tube sets were. Consumers decided they would rather more money for better value flat-screen TVs. Samsung and LG Electronics have both posted record TV sales in China this year, driven by rural consumers.

The lesson there is that companies shouldn't just bring in cheap, watered down versions of their products. They need to bring in their top lines too, although they might have to change those products a bit.

Amway, the maker of cleaning products, is a case study in how to do it right. It sells detergents at far higher prices than competitors like Procter & Gamble's Tide. Customers believe Amway's products are superior. They can't afford large packages of the soap because the cost is too high, so Amway sells small packages at a final ticket price acceptable to consumers. Still, the price per gram is high, and Amway enjoys fat margins.

Brands can have to change their packaging, as Amway has done, to accommodate lower incomes while feeding the demand for premium products. You might need to have packages that can be packed easily on a bicycle cart, as that is how many products are distributed in poorer regions. Or you might need to have a larger package, if that will look like a better value to consumers even when the per-gram price is the same.

Second, while many Americans fear the "Made in China" label, consumers in third- and fourth-tier cities are even more afraid. They therefore base their buying decisions not just on brand but also on retailer.

Only a decade ago, 80% of food and household product sales happened at mom-and-pop stores. My firm, the China Market Research Group, estimates that over the next three years half of all sales will be made by big-box retailers like Wal-Mart. The shift is being driven by consumers who are scared of poor quality and fake products. A 28-year-old mother in Chengdu told us, "I will buy milk powder in Auchan because their quality-control standards are better than in smaller shops. The brand is important, but where you buy is even more so. There are so many fake baby products."

In our research we found that the majority of consumers were willing to spend 10% more for ingestible products from trusted sources. Companies not only need to build consumer trust; they also need to develop the right distribution strategies and understand the shift in retailing taking place in China.

No matter what policy changes Beijing enacts, retired consumers who are cautious because of many cycles of economic hardship will be hard to win over. Developing markets will continue to be what drives China's retail economy, and they are what companies looking for high growth need to focus on. To be successful in developing regions, make sure you are selling products not just on price but on value, and be sure you are doing so through sales channels that consumers trust.

Shaun Rein is the founder and managing director of the China Market Research Group, a strategic market intelligence firm. He writes for Forbes on leadership, marketing and China. For more from Shaun Rein, click here.

Disclosure: none