For U.S. Brands, There's No Middle In China's Middle Class

by: Shaun Rein

This column originally appeared in Bloomberg BusinessWeek.

In China, a trip to Starbucks (NASDAQ:SBUX) isn't just about grabbing a tall latte in a cardboard cup. Most American products are priced higher in China than in the U.S., which gives the Seattle company's shops a patina of luxury and self-indulgence that they don't have back home. Many Chinese consumers go to Starbucks with friends, family, or business partners for the lifestyle experience, rather than to drink the coffee. Starbucks has understood how to tap into the demand for premium experiences by tweaking its marketing to go upscale in China, rather than transferring the same mass-market image it has in America. The formula is working: The company's Asia-Pacific boss, John Culver, on April 1 told Bloomberg News about plans to triple the number of Chinese outlets to 1,500 by 2015, making China Starbucks's largest market outside of the United States.

Starbucks is just one of many Western consumer-products companies taking aim at China. Brands from theGap (NYSE:GPS) to Weight Watchers (NYSE:WTW) to American Eagle (NYSE:AEO) have also announced plans to target the emerging Chinese middle class as a major driver of growth. In November, David Zoba, Gap's senior vice president for global real estate, announced aggressive growth plans for China. He said the San Francisco-based apparel retailer plans to open 45 stores there by the end of 2012-up from eight at that time-with the goal of hitting $1 billion in revenue there during the next three to four years by targeting the country's growing middle class.

These companies need to be wary, though. China's middle class does not really exist, at least by the American definition. Many analysts define the 350 million Chinese who live in households that earn between $6,000 and $15,000 a year as middle class. However, Chinese consumers with this socio-economic background do not exhibit the same hopes, aspirations, and shopping habits of middle-class Americans. As a result, brands that emphasize a middling position will not appeal to consumers there.

To understand what these consumers want, China Market Research Group has talked with thousands of Chinese in 15 cities in the past year. Our research suggests that most "middle class" Chinese consumers consider themselves on their way to riches, despite the slowing economy. Their salaries have been rising in double digits or more for the past decade. Everyone knows someone who was tilling farms 15 years ago who now is a multimillionaire, driving a Mercedes, and living in a posh villa. Many of the Chinese we spoke to think they, too, can get seriously rich.

Consumers are likely to either save up to buy high-priced brands such as Louis Vuitton (OTCPK:MAGOF) or Tiffany (NYSE:TIF) to show off status and sophistication-or trade down to discount brands. Companies that position themselves in the middle place themselves in no-man's land and are unlikely to gain much traction.

Consider the Gap, which sells jeans for between $50 and $200. Time after time, female consumers told us they would prefer to buy jeans from brands like Japanese retailer Uniqlo (OTC:UGTRF) at a fraction of the cost or save up to buy premium and luxury brands such as Armani jeans. One 27-year-old Shanghai woman making $300 a month told me she skipped lunch for five months to save enough to buy an Armani jean jacket. For her, the status associated with Armani proffered better value than multiple pieces from Gap.

Starbucks is one brand that understands that the Chinese will spend a lot for premium products and has adjusted its pricing and marketing strategy accordingly. The coffee retailer's outlets are more profitable in China than in the U.S., according to Troy Alstead, its chief financial officer. In Asia, the company's operating margins were 34.6 percent in 2011, vs. 21.8 percent in the United States.

At some point-perhaps 10 years from now, as it becomes impossible for China to sustain fast-paced growth-China's middle class will truly be middle class in aspirations and economic potential. Brands will be able to emphasize a middling heritage. Until then, however, China's buyers offer far greater similarities to Indian and Russian consumers, who spend on luxury for some products but are price sensitive on others.

Rein is the founder and managing director of the China Market Research Group, a strategic market intelligence firm focused on China. He is the author of "The End of Cheap China: Economic and Cultural Trends that Will Disrupt the World."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.