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Chinese Companies Go Abroad (Part 10: The Retail Sector)

|Includes: Morgan Stanley China A Share Fund (CAF), FXI, GXC, HD, M, PGJ, SHLD, WMT
Part 10: Retail

The following is part ten of a ten part report evaluating the progress of key Chinese industries as they expand overseas (see the introduction to this series, part 1, part 2, part 3, part 4, part 5, part 6, part 7, part 8 and part 9). CMR interviewed several hundred key executives in each of ten industries to better understand the extent of their globalization thus far, their goals and plans going forward, and the major challenges they are meeting along the way. This section describes the opportunities and challenges facing China's retail industry.

China's retail industry has been changing rapidly since the institution of China's economic reform policies in the early eighties. "Retail" was fundamentally different prior, when demand consistently outstripped supply and retailers merely sold whatever factories produced without concern for consumer preferences or competition from other retailers. Before the 1990s, consumers went to department and mom & pop stores for any/ all of their shopping needs. Only in the early 1990s did other types of retail stores such as supermarkets, convenience stores, and specialty stores come into being. Retail revenue growth has substantially outpaced China's rapid annual GDP growth since. In 2007 retail revenues totaled 8,921 billion RMB, a 16.8% year on year increase. We expect 2009 to see 16-18% retail sales growth, even in the face of a global recession as Chinese consumers continue to spend and remain relatively optimistic.

Even compared to other mainland Chinese industries, the retail industry is quite young, and farther behind in the move abroad. However, while only one of ten respondents had made a meaningful push into overseas markets, expansion abroad is on the minds of many respondents, and many are already developing plans as to how to best realize this goal.

Reasons for Staying Home

Of those companies who do not plan to move overseas within the next five years, most companies' main reason is that they are prioritizing opportunities at home. As one company told us, "the domestic market itself is still large for us. Our current market share is only about 10%. We want to gain more market share at home before we make any plans to go abroad." Given the young status of the domestic Chinese retail industry, many companies feel there is much more work to be done at home in terms of building capital and resources before they can begin to consider moving overseas.

Currently the majority of Chinese retailers are still regional. Given the tremendous diversity between regions in China in terms of disposable income, consumer sophistication and product needs, competition, local government policy and a host of other factors, expanding domestically can be a big enough challenge in and of itself. Many companies have had enough trouble managing their supply chains as they expand throughout China to discourage them from making the move overseas in the near future. Even Bailian Group, China's largest retail company, is still working to establish itself as a truly national chain, currently focusing on strengthening operations in Shanghai and the surrounding Yangtze delta area. As competition increases at home especially due to market entry of foreign chains such as Wal-Mart (WMT), Home Depot (HD), and BestBuy (BBY), companies like Hualian, Lianhua, Suning and Gome have their hands full operating at home, let alone going abroad.

Furthermore, many of these companies feel development across China is a crucial step that must be taken before any meaningful attempt can be made to move overseas. Unlike in other industries where companies can rely on OEM or pure export at first, retail companies must start straightaway with the more challenging steps of localizing management, developing and managing local supply chains, managing logistics, and a wide range of company-specific issues to begin the process of moving overseas. The initial investment too is enormous and has to fit local tastes right away as it is hard to resurrect a failing retail outlet. Many respondents figure that developing first into other regions of China will help them gain experience in managing cross-regional operations and develop skills crucial to expanding abroad.

Retail Pioneers

The difficulties China's young retail industry faces at home have limited Chinese retail companies' expansion abroad to date. Still, the majority of large industry leaders consider expansion abroad an important future goal. One pioneering company, the Beijing Hualian Group (SHA:600361), is already succeeding overseas, and China's largest appliance retailers, Gome and Suning, are taking steps to prepare for their own move. However, Gome's development plans might be curtailed as its founder, Huang Guangyou, has just been arrested for reputed financial improprieties.

Leading retailer Beijing Hualian Group took its first step overseas in 2005, when it purchased Seiyu-Wing On, a Singapore department store chain, for S$4 million SGD ($2.36 million USD). Hualian chose to make Singapore its first stop overseas due to lack of language barrier and cultural similarities with China, especially in retailing culture. In order to learn more about the local market and guarantee stability in terms of procurement, sales, and marketing, Beijing Hualian kept Seiyu's local executives and employees and only changed the store name in 2007 from Seiyu to BHG ("Be Here for Good Things", and Beijing Hualian Group). BHG smartly hired a PR company to help with its re-branding campaign. In addition to orchestrating events and promotions in-house, BHG tasked its PR partner with communicating its growth and success to consumers by publicizing its corporate strength, excellent service, and innovations in retail.

Since 2005, BHG has opened another store in Singapore and brought the international brand name back to China to help boost sales in a struggling Hualian, as the mainland locations are called, in Guangzhou. BHG hopes to move into other markets in Southeast Asia such as Thailand and Malaysia when the timing is right.

BHG's success should be inspiring to companies like Gome and Suning. China's largest appliance retailer, Gome opened its first store in Hong Kong in 2003, where it now has fourteen locations including one flagship, and over 30% of total market share. It entered Macao in 2006, where it currently has three locations. Suning, China's second largest appliance retailer, plans to open locations in Hong Kong in 2010. While neither of these respondents expressed specific plans to begin the move outside China within the next five years, both retailers plan to use their experience in the Hong Kong and Macao markets as a tool to prepare themselves for such expansion.

Going Forward

While the challenges facing China's retail industry are not insignificant, CMR is optimistic for these companies in their move abroad long-term, once international consumer spending picks up again. Many international chains like Sears (SHLD) or Macy's (M) will have difficulties in the recession which will give Chinese firms the opening to move abroad. Going forward, Chinese retailers should learn from what companies like BHG have done well. In particular, BHG was smart in the careful and deliberate way it established itself in Singapore. Like BHG, retail companies going abroad should consider M&A or partnerships with an existing local retailer, keeping the local executives and management team for at least two years after entering the market, waiting to change the store name until new operations are running smoothly, and hiring third party advisors such as a PR team on the ground to help win the hearts of local consumers and team members.

The next several sections of this report will be published on Seeking Alpha by product category. For more information about this report and accompanying charts and graphs, please contact CMR directly at

CMR Senior Analyst Ben Cavender, Analysts Natalie Zhu, Meredith Sun, and Charlotte MacAusland, and Summer Intern Christie Sze Contributed to this report.