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Foreign SMEs' next big shot: China’s consumer goods market

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By Chamber member company Vistra.
 
 
China is gradually shifting to a consumer-driven economy, with urbanisation and rising household incomes. However, opportunities for domestic consumer goods companies are few and far between, with analysts pointing out that such companies face persistent price deflation in a low-inflation environment, along with flat sales volumes in overcrowded markets. This is partly due to overcapacity, which is affecting several sectors, including food and beverage, retail and textile.
 
Foreign brands win consumer favour
However, while domestic brands are suffering, the marketplace is increasingly filled with competing foreign brands, which are often perceived as higher quality and fashionable, and are winning consumer preference. E-commerce business models are making it easier to reach consumers, while lower logistics costs and reduced import tariffs are also playing an important role in the rise of foreign consumer brands. But while it is not surprising to hear that big brands are making their moves, the market is attracting some heroic small-sized businesses and a very determined bunch of entrepreneurs looking for new expanding markets. 
 
Saverio Paolillo is a 30 year-old Italian from Torre del Greco, a small city on the shores of the Gulf of Naples known for its production of coral jewellery since the seventeenth century. Saverio is the fourth generation of a family of coral traders and, with his dad and three siblings, runs a business that sells coral in three continents. Four years ago, Saverio moved to Guangzhou, the primary jewellery hub of China, to tackle a market that he defines as ‘astonishing for the numbers, crazy for the way people make purchase decisions … and so difficult to understand that it became a permanent challenge’. Business has been very good for the first three years, ‘so good that I wasn't even able to leave Guangzhou,’ he adds. However, in the last six months something has changed and Saverio and Gioia, a lovely Chinese lady who masters the Italian language with a thick Neapolitan accent, have started to look for more opportunities in other major areas of China, such as Beijing and Shanghai. 
 
‘I think it would be nice to live in China for a few more years and build strong sales channels. It is difficult as there are a lot of competitors and a lot of fake products around here, but clients are getting sophisticated. Coral has been popular in China for centuries, particularly because of its red colour … our coral type (coral rubrum) is also allowed by CITES (the Convention on International Trade and Endangered Species of Wild Fauna and Flora) while most of what is sold in Asia is not,’ Saverio concludes.
 
Image Copyright Vistra
 
China’s emerging middle class fuels consumption
As a recent report from McKinsey shows, China’s consumer spending data is not a reliable measure of prosperity and its economy is now too complex and distorted; what really counts is household income. China has an emerging middle class, with higher average household incomes and steadily rising consumption. Furthermore, the size of China’s higher average household income is ahead of other emerging markets, which makes China an unprecedented, unique and exciting phenomenon. The report forecasts a growth of 6% and above until at least 2020 for semi-necessities, such as clothing and household products, and discretionary categories of goods, such as transport and recreation. Moreover, a lot of income in China is unreported, which means that actual numbers are probably even higher.
 
The spending attitude in China is far heathier than in developed countries, where consumption has stalled in recent years. Another recent study from McKinsey found that 55% of consumers in China are confident that their incomes will rise significantly over the next five years. Consumption is rising 14% a year among the under 35s (twice that of older generations). Boston Consulting Group predicts that even if economic growth falls to 5.5%, China’s consumer economy will expand exponentially, creating an additional mass equal to the entire consumer economy of Britain or Germany.
 
Exporting to China: the next big trend?
While many big brands seem very confident about these trends – Pepsi has just opened its first Quaker Oats manufacturing plant in China, Ferrero has recently opened a plant in Hangzhou (its biggest investment outside of Italy), and McDonald’s and Starbucks are already pushing to add 1,250 and 500 more outlets respectively – smaller players must be more cautious.
 
Anna and Artem are two young Russian entrepreneurs that, facing a troubled economy at home with their local currency heavily devaluating, decided to launch an e-commerce platform called dakaitaowa.com, importing Russian-manufactured goods to China. They sell Russian products including canned food, beverages and cosmetics. After doing their homework and putting together a strong business plan, they approached several potential investors, until they found people interested in funding them. The sales in China are made both offline and online, taking advantage of the new e-commerce wave. The decrease in the Ruble and a strongly appreciating RMB has created an additional competitive advantage. 
 
As Anna described it, ‘business in China is not easy. There are so many papers to complete and so many authorities to talk to … but the opportunities are there and you can feel it every day … The government were friendly and supportive of our project, but the procedures of establishing a business are complicated and budgeting is not easy … even opening a bank account took one and a half months, which is a long time, even in Russia. In such a complex environment, choosing the right advisers is key and can easily be the difference between success and failure.’ 
 
With a long history of excellence in producing consumer goods, exporting to China could be the next trend for developed countries such as Australia, Italy, France or Spain. Developed countries that are able to produce more than they need and that have built brands over the decades tend to excel in exporting consumer and capital goods to China.
 
In a recent Special Report on China, The Economist (9 July 2016) lays out all of China’s paradoxes regarding politics, society and the distribution of wealth. However, the article still struggled to explain the resilience of the current Chinese economic model. The article mentioned McKinsey’s data once again, which estimates the Chinese middle class to have reached 225 million households – and an additional 50 million households in 2020 – compared with only 5 million in 2000 and with an annual income spreading from 11,500 to 43,000 USD. 
 
Tahsin Toraman is a businessman that relocated to Shanghai three years ago. With a strong background in medical consumables, Tahsin intends to tap into one of the biggest opportunities of all time: China’s aging population. His young family business already involves three generations, as both Tahsin’s parents run the business in Turkey and his first daughter was born in Shanghai last year. 
 
‘To come to China was a tough decision but the opportunities here are unbelievable … to build a business from scratch is probably more difficult here than anywhere else. It can also be very rewarding,’ says Tahsin. ‘You are on your own and all the information is confusing … before choosing my service providers, I met 20 of about 40 that I found over the internet … believe me, it wasn't about the money … it was about trust. They had to show me that they knew what they were talking about, solve my problems and that I could trust them. This place is so difficult that you need to be able to rely on your advisers,’ concluded Tahsin.  
 
Conclusion
There are several recurring issues that small (and large) foreign businesses face when doing business in China, and several constants that characterise those that are successful. An unpredictable legislative environment, administrative issues and discretionary law enforcement are three of the main recurring issues pointed out by longstanding resident foreign businesses. The result is that many small businesses will have their best people working to solve these problems instead of focusing on generating business. The only solution, to at least mitigate risks here, is to find a trusted adviser that can navigate you through these challenges. Do your homework, identify the right advisers and do not hesitate to ask for references.
 
As China is becoming a second-home market for many SMEs, you will need to send your best people on the ground to stay on top of the changing market, while still understanding its fundamental Chinese characteristics. Local managers will need direct access to headquarters to keep abreast of changes and adapt to new challenges and opportunities. 
 
As the war for talents goes on, companies will struggle to recruit and retain good employees. Identifying strong technical skills in prospective local employees, though less easy to identify, may be more important in developing business than individuals with strong English-language skills. 
 
Finally, newcomers will need to budget wisely as China is not cheap, especially when the aim is to sell consumer goods and services, which require to be localized downtown big cities. Rent, human resources and administration costs might be very high and taxes are not as low as you would expect. However, as Tahsin rightly puts it: ‘to come to China was a tough decision but the opportunities here are unbelievable’.
 
By Rosario Di Maggio
Director of Business Development, Vistra Shanghai
 
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