Ctrip, Baidu: Growth in China's 2nd Tier Cities

Includes: BIDU, CTRP
by: Shaun Rein

Throughout the past 3 months I have been traveling all over China to manage several consumer insight projects for clients. Some of our clients in the fashion, cosmetics, and home decoration sectors are trying to get a better understanding of Chinese consumers in 2nd tier cities like Chengdu, Nanjing and Tianjin to see if it makes sense for them to focus expansion efforts there as competition in 1st tier cities like Shanghai and Guangzhou heats up.

Last year in a commentary for BusinessWeek I wrote that my firm is recommending to clients that they at least consider 2nd tier cities as consumers there are dying for more products and services and increasing disposable incomes. These markets might be less developed now but they afford great opportunities for future growth. For instance, the average China Mobile (NYSE:CHL) user spends a little over $10 USD a month. The potential to up-sell to these consumers is huge and is where the next battlegrounds for the wallets of China’s 250 million strong middle class will take place.

Visits to these cities also gave me the opportunity to track the growth of some high flying Chinese companies like Ctrip (NASDAQ:CTRP) and Baidu (NASDAQ:BIDU) to gain a better perspective on their long-term viability.

My regular readers know that Ctrip is one of my favorite companies because they are well-run, hit a niche that consumers want, and have tremendous growth potential as Chinese continue to travel both for pleasure and for business. I have written repeatedly about Ctrip for Seeking Alpha, so I do not need to go into the macro numbers again here.

What impressed me during my recent travels was Ctrip’s increasing presence in all of the cities we have been to recently – Chengdu, Tianjin, Shanghai, Beijing, Guangzhou, Xian, and Nanjing.

At the airports in Chengdu and Guangzhou, Ctrip employees actively passed out membership cards and actually helped people get into taxis and buses. If any of you have been to airports in China where incredibly unhelpful guards abound, this is a great service, especially as Chinese consumers are demanding better service in retail stores. Such top of the line service will increase brand loyalty with Chinese consumers.

In Shanghai, I even had one Ctrip employee help me check-in into the new e-ticket machines and then pass me a Ctrip VIP card. Where were the employees from Air China and China Eastern (NYSE:CEA)? Although better than the atrocious United Airlines (UAUA) in the US, Air China and China Eastern have lack luster service in airports, so Ctrip’s service really stands out.

Ctrip has also begun accepting credit cards much more easily as China has transitioned to virtually a 100% e-ticket market. I can now book a ticket with my credit card and have Ctrip deliver a receipt to me or I can pick up the receipt at the airport. Accepting credit cards will be important for all retailers going forward as China is becoming a credit society. The difficulty before in paying with a credit card with Ctrip often left me buying from my local travel agent. I have now shifted 100% of our company business to Ctrip because we can now pay with a credit card.

It is clear to me that Ctrip is making the marketing and e-commerce moves necessary to trounce local travel agents and other travel sites like Elong (NASDAQ:LONG) and Mango. It is also a scalable business as consumers travel more and lodge in better and better hotels as they get richer and thus spend more per purchase.

The trips around China also gave me a chance to evaluate how important Baidu (BIDU) has become in influencing consumer decisions on a daily basis. In every city that I went to China’s baby boomers were quick to list Baidu as one of the first places that they went for information on products and brands. While Google (NASDAQ:GOOG) is making strides in China as I have written before, especially in 1st tier cities, it is still getting beat up in the 2nd tier cities.

It is not just consumers in Shanghai or Beijing that are taking advantage of internet services in China. Consumers in 2nd tier cities are increasingly tech savvy and more and more are turning to the internet as a way to discuss products and learn from their peers. One person that we interviewed in Chengdu summed it up this way “through Baidu I can find relevant information faster than anywhere else, when my friends or I want to learn about a product this is the easiest way to learn.”

I expect that Baidu will only become more important in directing consumers to relevant information and it will increasingly become a portal for plugging into a growing trend towards e-commerce. I still think Baidu’s valuation is absurd and that Google is catching up quickly, but Baidu still has the lead.

Overall, the trips have showed me that the future is now in China’s 2nd tier cities. MNCs and Chinese companies alike have to position themselves well for the long-term in these regions as I wrote in Forbes, or they will lose out on the real growth potential in China.

Both Ctrip and Baidu seem to be getting it and will continue to grow. Even with the sub-prime mess in the US and potential overvaluation of some Chinese banking and energy stocks (NYSE:PTR) (NYSEARCA:FXI), Ctrip and Baidu will continue to expand and make money.

CMR Analyst Ben Cavender contributed to this article.

Disclosure: Shaun Rein owns shares of Ctrip, ChinaMobile, FXI, and Google