“What is the best way to approach China’s many markets?” “How do I effectively identify and build relationships with local distributors to gain access to markets outside of China’s central hubs?” These questions resonate from the offices of the vast majority of foreign executives charged with selling consumer goods in the Greater China region. Multinational companies that have successfully imported their international brand to China’s major metropolises are struggling to understand what it will take to reach the next tier of Chinese consumers. The China Observer has previously written about this topic and has spoken with fellow China consumer insiders such as Oxford’s Karl Gerth and McKinsey’s Vinay Dixit to gain additional perspective into what approach foreign multinational companies should adopt to succeed in China’s next tier.

While there is no standardized approach, the following examples demonstrate how selected domestic firms have been able to achieve success in more remote Chinese markets.

Li Ning – Athletic Apparel

Li Ning, founded in 1990 by a former Chinese Olympic gymnast of the same name, has turned up the competition against top foreign multinationals like Nike and Adidas in higher-end markets. However, much of Li Ning’s success to date can be attributed to its operations outside of tier one cities. Tom Doctoroff explains in this article, that “Li Ning and Anta are not competing directly with Adidas and Nike, but the pie they are eating is growing larger and larger, while Adidas’ and Nike’s pie is not growing at the same rate.” Doctoroff is referring to the fact that Li Ning’s strength in China’s smaller cities is propelling it forward much faster than competitors in tier one cities which are not seeing the same rate of growth which led to their initial success in China.

Lenovo – Consumer Electronics

Lenovo is best known for its expanded international presence after it acquired IBM’s ThinkPad line of notebooks for roughly $1.75 billion in 2005. Lenovo is increasingly focusing on what it defines as China’s ‘emerging markets.’ Since early 2009, desktop sales in the emerging markets cluster has increased from 45 percent to 70 percent of Lenovo’s total desktop sales. Over the same period of time, notebook computer sales in these markets increased from 30 percent to roughly 50 percent of total notebook sales. It has been just 5 years, since Lenovo first began to focus on China’s rural markets, but the company will likely continue to move forward in this direction as China is expected to become the world’s largest PC market in the next year.

CR Snow – Food & Beverage

When outside observers hear that China is the world’s largest beer market, they often assume the top selling beer is Tsingtao. Even those of us in China find it surprising that the top beer in China is Snow beer. The case of Snow beer differs slightly from the two previously discussed here, because CR Snow is a joint venture between China Resources Enterprise Ltd and South Africa’s SABMiller. However, the key to CR Snow’s success has been its focus on lower tiered cities in China’s regionalized beer market. CR Snow implemented a Greenfield expansion program in 2006 through successive acquisitions of breweries in Dongguan, Lanzhou, Harbin, Yanjiao, Nanjing, Anhui, Lioaning and other locations.

As executives at companies like Li Ning, Lenovo, CR Snow and even Haier will tell you, the market opportunity presented by China’s next tier of consumers is too big to pass up. Yet, these markets tend to be quite regionalized with fierce local competition, and there is no set methodology to win. It will be up to each company to come up with their own distinct strategy to expand beyond China’s first and second tier to realize the opportunities presented in this next ‘frontier.’

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In order to understand the future trajectory of China’s domestic consumer market, it’s important to gain an understanding of the historical context of consumerism in China. Karl Gerth is a professor at the University of Oxford who teaches modern Chinese history with an emphasis on consumer culture. He brings a truly unique perspective combining both a deep understanding of contemporary Chinese history with actionable business insight for the present day and beyond.

Part I:

Joel Backaler: In your new book, As China Goes, So Goes the World: How Chinese Consumers are Transforming Everything, one of the questions you aim to answer is, “what are the implications for China and the world of hundreds of millions of Chinese people adopting Western lifestyles?” Can you please highlight the most significant implications?

Karl Gerth: There is, of course, no single positive or negative implication of Chinese consumerism.  Rather than focus on the good or bad implications, I think it is more helpful to think of them as wide-ranging, interconnected, and often both good and bad.

Take automobiles.  A few decades ago few Chinese owned cars; now China has surpassed the US as the world’s largest car market.  This is good news for any number of reasons.  Who would begrudge tens of millions of Chinese the opportunity to enjoy some of the same things that we do?  And thanks to Chinese consumers multinationals such as GM, which now sells more cars in China than the US, rely heavily on China for their profits.  You might say many who have invested in the stock market have already been benefiting from Chinese consumerism.

But there are many more implications.  China has vast ambitions to create its own national brands of everything, including automobiles.  It wants to move up the value-added chain and create a regulatory environment to promote Chinese brands.  The strategy has successes.  Already some two million Chinese work in their auto industry, including Chinese manufacturers such as Geely, which just bought Volvo.  Like the US with its recent “cash for clunkers” program, in China it has become a national economic necessity to promote car ownership.  We’ll see how Detroit handles China doing for cars what it did for plastic deck chairs and so many other consumer goods: make them so inexpensive they become ubiquitous.  If Americans cannot name a Chinese car brand yet, I suspect they soon will.  And, of course, we’ll also see how well the planet can handle the extra carbon emissions and the intensifying competition for oil.

Joel Backaler: So what you are saying is that in China as elsewhere consumerism begets more consumerism?

Karl Gerth.  Yes, the most significant implication of Chinese adopting Western lifestyles is that, in doing so, China, like the US and EU countries before it, is deeply committing its economy and society to consumerism.  China is increasingly implementing policies designed to get its citizen-consumers to consume more and more, regardless of the implications.  The spread of consumerism in China will accelerate some opportunities for companies such as GM, Yum! Brands, McDonalds and Starbucks but it will also continue to create serious global challenges.  Once you have millions of people working in the car industry and once you have built the largest roadway network in the world, there is no simple road back to bicycles.  The same can be said of so many other aspects of Western consumer lifestyles: once Chinese are accustomed to things such as fast food and indoor plumbing, it’s hard for them to go back.  Likewise, it’s hard for politicians whose credibility and promotions are riding on hitting economic growth targets.  This deepening commitment to consumerism is creating a stream of opportunities and a tidal wave of new global challenges.

Joel Backaler: In As China Goes, you argue that deliberate government policies aimed at reducing the country’s overreliance on exports is transforming China from a country of scarcity and frugality to one in which the consumer ethos rules.  In your opinion, when will Chinese consumers, who are traditionally thought of as savers, be renowned for their spending?

Karl Gerth:  The consumer ethos clearly rules now for many tens of millions and yet remains irrelevant for hundreds of millions.  For many decades to come, China will remain both a spectacularly poor country and enviably rich country.

There is plenty of evidence that tens of millions already have become more free-spending than frugal.  This certainly applies at the top end, where the Chinese luxury market is quickly becoming the world’s largest, leading to the success of LVMH, Richemont and Pernod Ricard.  This is already having worldwide repercussions not only for the bottom lines of luxury brands but also in areas such as tourism.  Major shopping streets such as Bond Street in London and Fifth Avenue in New York are already heavily dependent on Chinese tourist spending.

We can expect much more.  Encouraging consumerism is, after all, the new party line.  Chinese have new opportunities to borrow and reverse the country’s culture of saving, creating what is known in popular parlance, as mortgage slaves, car slaves, and a new class of young big spenders that has become known as the “tapped-out-by-the-end-of-the-month class.”  There are plenty of other policies designed to get Chinese to spend more, for instance, by giving civil servants pay raises, raising personal income tax exemptions, abolishing agricultural taxes, and allowing the Chinese currency to appreciate (within limits).

Of course, there are serious concerns about inequality.  China appears to be on its way from being one of the world’s most equal to one of the world’s most unequal societies.  Aside the political and social justice issues, this inequality may mean that the long-desired massive Chinese middle class may never emerge.  But, then again, maybe this problem is not unique to China.  Noble-prize winning economists such as Paul Krugman say the US is quickly losing its own middle class.  China may just skip the middle, or middle class, stage and go directly to solidifying a two-tiered society.

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PART II:

Joel Backaler: In your previous book, China Made: Consumer Culture and the Creation of the Nation, you argue that Chinese consumerism and economic nationalism developed simultaneously. What are the implications for contemporary China? Many western multinational companies operating in China have begun to express frustration due to increasing protectionist measures. General Electric’s CEO Jeffrey Immelt recently made a public statement of the sorts. Do you feel that this protectionist sentiment is primarily at the government level, or do you believe that Chinese consumers are also looking to buy China-made products? How do you think this type of favorable policy will impact western multinational consumer packaged goods and retail companies in China?

Karl Gerth: It’s complicated. Before considering China, contemplate how these same issues relate to America or most other countries. As in other countries, the Chinese government sees itself as in the business of promoting Chinese business. A hundred years ago, China struggled to catch up as a global manufacturing superpower. Mission accomplished. Now the Chinese recognize that in the post-industrial reign of service economies, their country needs to become a branding superpower. Chinese government and business leaders view domestic ownership of global brands and intellectual property as symbolic of national wealth and power, the economic equivalent of hosting the Olympics but much more permanent. These efforts to promote Chinese businesses and brands are even more pronounced when done on behalf of massive state-owned enterprises like China Mobile, which has the world’s most mobile phone subscribers.

And it’s not just government policy to promote Chinese products. Chinese consumers often want to “buy Chinese.” For over a hundred years, they have periodically had radical equivalents of the Buy American campaigns we sometimes see in the U.S. (you may recall that in the mid-1990s even Wal-Mart launched such a campaign). So, yes, that sentiment exists in China, too. But the same consumers who support Buy Chinese campaigns don’t necessarily buy Chinese themselves, especially when imports are seen as safer, less expensive, or more fashionable. A few years ago during one of the periodic anti-Japanese protests, it was easy to spot protesters armed with Japanese brand phones and cameras. Navigating these obvious but subtle policy and consumer contradictions may be the toughest aspect of marketing in China.

Joel Backaler: What do you feel western consumer packaged goods companies selling to China’s mass market should consider in their branding? Should they try to localize their brand perception in the Chinese marketplace or stay “western” in their messaging?

Karl Gerth: Both. They should localize and stay “western.” Depending on the constantly changing circumstances, each has its advantages.

Of course, they need to localize while continuing to play to their strengths, especially around issues of quality, safety, and leading technology. But such positive associations with “western” and Japanese products are not fixed. Indeed, I think the government-efforts to promote Chinese brands have had some success in weaning Chinese consumers from an automatic preference for international brands. This can be seen in the growing popular indignation of Chinese consumers toward foreign companies. China’s aspiring and middle-class consumers increasingly declare that multinationals selling in China take market access for granted, cut corners on safety and quality, ignore Chinese laws, and dump their low-end products there. A sentiment popularly held about Japanese companies, for instance, is that they sell their highest-quality products in European and American markets, their second-best domestically, and their lowest-grade in developing markets such as China. One woman I interviewed, for instance, insisted that Japan sends China mobile phones that couldn’t make it in Japan.

It’s worth noting that the reverse occurs, too. Chinese brands want both to appear modern/western/cosmopolitan and Chinese/traditional/patriotic, depending on circumstances. Chinese companies want to convince consumers they are buying the best but also that they are doing the right thing for China. This is especially the case during upsurges in patriotic sentiment, say, surrounding the Olympics or following a perceived international insult. Perhaps the best strategy is to keep an eye on Chinese competitors and to triangulate accordingly.

Joel Backaler: Looking ahead at the next 30 years, what are your predictions for the top three changes in the consumer preferences of China’s mass market?

Karl Gerth: The major influences to consumer preferences will depend on how China handles three critical issues: climate change, an aging population, and intellectual property rights.

It’s easy to imagine green products and services becoming more popular either directly as a consequence of growing environmental awareness or indirectly as a consequence of government policies such as tougher fuel efficiency standards, tax rebates for energy-efficient appliances, and so on. Similarly, we’ll see a reverse of the “little emperor” situation of the past three decades, where four grandparents and two parents spoiled one child. Now those same children will struggle to support their parents and grandparents. But I think the most interesting issue to watch will be whether China can and does do more to protect intellectual property rights, which are not only the foundation of corporate research and development but also of brand stability. After all, why bother building brands if someone’s just going to sell much less expensive knockoffs?

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The British Chamber of Commerce recently interviewed me on the topic of luxury consumerism in China for the Spring-Summer issue of their business publication, the ChamberEye. I follow an interview on China’s middle class consumers with Tom Doctoroff, CEO of JWT Greater China and author of Billions.

I have included selected responses below, but the complete online version will eventually appear on the ChamberEye site here.

What is the current state of China’s luxury consumer market?

China is currently the fastest growing and second largest luxury goods market in the world, second only to Japan. It is expected to reach the number one spot by as early as 2015. In 2009 Chinese consumers purchased 27.5% of the world’s luxury goods at a total of 9.4 billion USD, in comparison to 2004 when the total was only 2 billion USD. The rate at which the luxury market has grown is tremendous having both the world’s second largest diamond market, and the number one automobile market.

It is important to note that luxury goods consumption is not limited solely to tier 1 cities such as Beijing and Shanghai. On the contrary, the majority of luxury consumers are growing in areas outside of China’s major cities.

Can you provide a few examples of Western multinationals that have localized their product for China’s luxury market and achieved success?

While General Motors is not seeing the growth it once experienced home in the US, it is seeing spectacular results in the world’s new largest auto market. In recent years GM fueled its success by localizing automobiles specifically for the Chinese consumer. It has been so successful that much of the innovation in their Shanghai center have been exported into the designs of their cars in developed markets. One example is the Buick LaCrosse in China. GM’s design team in Shanghai completely revamped the original for the China market and enabled the company to sell nearly 110,000 units in just its second year in production.

Pernod Ricard, a French wines and spirits company is achieving great success with it’s Chivas Regal Scotch whiskey. Beyond localizing it’s staff and operations with a vineyard in northern China, the company has embraced the localization of how their product is consumed. Chivas Regal, a premium liquor, has always been looked at as a luxury form of alcohol that drinkers should savor the taste alone. Chinese luxury consumers came up with their own twist of mixing Chivas Regal with green tea. After an initial hesitance, the company has embraced this localized preference and Chivas Regal now sits only behind Rémy Martin cognac on a ranking of premium spirits in China according to a recent report by Credit Suisse.

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I came across this chart in The Wall Street Journal last week. It summarizes the results of HSBC’s “Affluent Asia Tracker.” According to the survey, the average age of the wealthiest 10% of investors in mainland China is 36, compared to an average age of 48 in Hong Kong.

This statistic reminded me of what McKinsey’s Vinay Dixit told me, about a key difference between Chinese wealthy consumers and their counterparts in developed economies:

“One key difference of Chinese wealthy consumers when compared to their counterparts from other countries is their youth. On an average, they are about 20 years younger than their cousins in US or Japan. We do expect that the wealthy consumers in China will retain this characteristic in the next decade as well.”

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Is China capable of producing global brands? Will Chinese companies ever be able to foster domestic innovation without technology transfer from western MNCs? These two questions are at the forefront of mainstream analysis on China’s next stage of economic development. Both the Economist and Washington Post recently published detailed articles addressing these issues, and I myself have written about Chinese local innovation in the past. I do not aim to answer these two questions in this article; instead, I would like to highlight a Chinese company with a global presence that is consistently coming up with targeted innovations for one of China’s largest consumer groups: rural consumers. No domestic consumer goods company in China is doing a better job at innovating and meeting the needs of these consumers than appliance maker Haier.

Haier is in the middle of an incredible market opportunity to benefit from government subsidies in excess of 15 billion RMB (roughly 2.23 billion U.S. dollars) for rural residents to purchase appliances. The government subsidies are aimed at increasing domestic consumption to diversify economic growth that has previously relied heavily on exports and infrastructure spending. According to this article the Chinese government reported that rural consumers purchased 41.7 billion RMB in household appliances as a result of the subsidies over the first 4 months of 2010 (equivalent to a 510 percent increase year-on-year). Accordingly, Haier’s growth in Q1 more than doubled.

How is Haier successfully targeting rural consumers in China? It does what every good company should do – Haier listens to its customers’ complaints and delivers products that address their needs.

Customer Complaint #1: “My washing machine won’t work after I use it to rinse the morning’s harvest.”

About 10 years ago, a rural farmer dialed into Haier’s call center complaining that his washing machine was full of dirt and not functioning properly. When the technician visited the customer’s home he discovered the dirt was not from the clothes the farmer wore in the field to harvest his potatoes, but rather from the harvest itself. The man had been using his washing machine to wash both clothes and potatoes. Instead of educating the farmer on how to properly use a washing machine, the technician returned to headquarters with the man’s feedback. Haier subsequently released a washing machine capable of washing both clothes and potatoes, the 2009 upgraded version of which led Haier to become the number one provider of laundry equipment in the entire world.

Customer Complaint #2: “My refrigerator is out of food because rodents ate it all.”

Haier’s customer service center later began to receive complaints that rodents were getting into their refrigerators. Apparently, when customers plugged the appliance into the wall and the compressor turned on, rodents couldn’t resist finding a new home inside. Again, recognizing that the needs of its rural customers differed from those in urban residences, Haier came up with a second innovation: the rodent-proof fridge. The specially designed refrigerator features metal plates to cover holes in the fridge and uses thicker “bite-proof” wiring.

The Complaints Keep Coming, and the Domestic Innovation Continues to Follow

Haier has gone on to produce washers that are able to peel potatoes, safely wash clothes typically meant for hand-washing, and even design a model for herders in Inner Mongolia and the Tibetan Plateau which helps process Yak butter – the innovations keep coming. However, does this mean that Haier is one of a multitude of emerging Chinese global brands? Does Haier’s success innovating for domestic rural consumers demonstrate that Chinese companies do not necessarily have to rely on technology transfer from more established foreign firms? All I think this proves is that Haier is an exception, and is doing an exceptional job creating products to meet the needs of a large portion of China’s domestic market. I will continue looking for others to do the same, and observe if Haier is able to take this level of innovation to the other markets it operates in globally.

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China’s e-commerce market represents a $38.5 billion dollar opportunity. In particular, the B2C market is experiencing tremendous growth. Online shops that may have began as a single person operation on Taobao.com, are incorporating into formal online businesses – while at the same time traditional businesses in China are stepping into the e-commerce arena as well.

In order to gain additional insight into how China-based businesses reach their overseas customers, I had the opportunity to speak with Alan Tien, General Manager of PayPal China. Tien oversees PayPal’s domestic Chinese payment platform Beibao as well as the acquiring of customers in China for the company’s international website.

Joel Backaler: You have certainly led an impressive career having started in the management consulting field with Accenture upon graduation from Stanford followed by management positions at a series of successful technology firms in the US. I am always curious to find out how people began their career in China. Could you tell us about what initially brought you to China and ultimately to your current position as General Manager of PayPal Beibao?

Alan Tien: At the bottom of the Internet Bubble bust, I was lucky enough to get a job at PayPal, an undiscovered jewel among all the rubble.  I was amazed at the beautiful business model, built on top of eBay’s astounding network model.  I started as a Product Manager in the tiny Merchant Services team, still called “off-eBay” at the time because we didn’t know any better.  After I launched APIs, Meg Whitman made China the top priority for PayPal, and I was put in charge of the BeiBao product development.  Upon launch, our China Country Manager Jeff Liao (now eBay’s GM for Greater China, SEA, and Japan) recruited me to China to become China Country Product Manager.  PM is a great role to learn the business, so when the PnL role opened up, Jeff offered it to me.  It’s been a fabulous experience so far, growing our business at double digit rates.

Joel Backaler: PayPal’s clear advantage in China is the fact that it is a global company. It is naturally positioned to act as an intermediary facilitating payment for Chinese businesses looking to conduct e-commerce outside of China. However, what measures are PayPal taking to further expand domestically for everyday Chinese online consumers?

Alan Tien: You are right in that we have amazing strengths as a global company, with presence in 190 countries, supporting 24 currencies, and being the preferred online payment method for 84m buyers around the world.  We are very focused on this “cross border” model, allowing our Chinese merchants to sell their goods abroad through a B2C channel.  As we announced earlier this year, we signed an alliance with China UnionPay which will open up the reverse channel, enabling Chinese consumers to shop and pay with their CUP card on any of our 8 million merchants around the world.  By facilitating this cross-border business for Chinese consumers and businesses every day, we are demonstrating the value proposition of our global business model for China’s burgeoning e-commerce market.

Joel BackalerThe reason I asked about opportunities to expand in China’s domestic market is because I feel that there is tremendous growth potential for 3^rd party mobile payment companies in China. This is an area that is still at the early stages of development with limited competition. I understand as early as three years ago, Alipay created a special team to develop solutions for mobile payments. Does Paypal Baobei have any plans to enter this space?

Alan Tien: I agree with your assessment of the opportunities in the mobile payment area.  PayPal is making significant investments in mobile, not just for China but globally.  Our iPhone app has just passed 2m downloads and we’ve recently launched our Mobile Payments Library for the Android mobile OS platform!  In addition, we are seeing many developer innovations based on our mobile payment platform all over the world, such as Magento’s new mobile solution in Europe.  With our mobile payment solutions available on the two leading Smartphone OSes and developers around the world using our mobile payment library, I’m confident that we have a strong position in the mobile payments area that we can leverage for the China market.

Joel Backaler: Much of PayPal’s growth in China will continue to come from small-mid sized Chinese companies looking to expand overseas. Many of these business owners do not know what e-commerce is nor do they understand the potential impact it can have on their business. How do you go about educating them about the benefits of e-commerce?

Alan Tien: You are absolutely correct in that e-commerce is a big mystery to most of the SMEs in China but they are learning that they must get in to the game quickly, or their competitors will kill them.  When you take this idea of e-commerce and extend it to cross border transactions, the difficulties are compounded.  That’s why we launched a Chinese portal www.paypal-biz.com to explain the intricacies of cross border B2C business.  We need to help Chinese SMEs to piece together the entire puzzle including the critical element of how to receive payments, especially from overseas buyers.

Joel Backaler: PayPal recently announced its partnership with China UnionPay. What do you see as the key advantages to this partnership? What do you think about some Chinese concerns regarding the sensitivity of Chinese account information being shared with a foreign company?

Alan Tien: As mentioned above, our CUP partnership will provide an easy way for millions of savvy Chinese consumers to purchase products from all over the world.  Consumers are right to worry about putting their financial information out on the web, especially with foreign or unknown merchants.  That’s one of the key reasons why a Chinese consumer would use PayPal – we keep the financial information private and secure, never sharing it with the merchant. We also use some of the most sophisticated fraud prevention tools in the industry to ensure the security of our system. Thus Chinese consumers will enjoy the same level of safety and security as our millions of users around the world.

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]]> http://thechinaobserver.com/2010/06/connecting-chinas-businesses-with-global-consumers-interview-with-alan-tien-gm-of-paypal-china/feed/ http://thechinaobserver.com/2010/06/what-are-china%e2%80%99s-consumers-eating-yum-brands-one-company-three-pillars-of-success-part-ii/ http://thechinaobserver.com/2010/06/what-are-china%e2%80%99s-consumers-eating-yum-brands-one-company-three-pillars-of-success-part-ii/#comments Sun, 06 Jun 2010 08:58:47 +0000 Joel http://thechinaobserver.com/?p=800

This is the second article in a series of posts on Yum! Brands’ success in China. For part one please click on “What are China’s consumers eating? Yum! Brands - One Company, Three Pillars of Success (Part I).”

Pillar III: East Dawning & Little Sheep Hot Pot - Trusted Local Chinese Dining

In 2005 Yum! Brands launched its East Dawning (Chinese: Dong Fang Ji Bai) chain of restaurants, focusing on local Chinese fast food. The Yum! Brands executives found that despite the success of KFC, most Chinese people will only eat Western food at most two times per week. They saw a need for a Chinese fast food chain – an opportunity to leverage their robust supply chain in China, to offer quality Chinese food at convenient and affordable prices. The chain is not widespread, but there are outlets in Shanghai, Beijing, Guangzhou and Xiamen. East Dawning is an on-going project for Yum! Brands and it will be interesting to observe how it will fare against other Chinese fast food chains like the popular Zhen Gongfu.

While East Dawning is Yum! Brand’s local equivalent of KFC, Little Sheep Hot Pot could be viewed as its local equivalent to Pizza Hut. Instead of creating its own local casual dining restaurant, Yum! Brands invested in Little Sheep Hot Pot. I wrote about Little Sheep hot pot almost 2 years ago and have since observed it develop into one of the best standardized Chinese casual dining restaurants. In March 2009, Yum Brands! bought a 20% stake in the Little Sheep hot pot chain. By October 2010 Yum! had increased its stake by an additional 7.5% - and currently owns 27.5% of the Hong Kong stock-exchange listed hot pot chain.

Yum! Brands diversified approach to China’s many markets allows it to tap into the taste buds of all different types of Chinese consumers. For those seeking Western fast food KFC is the go-to choice, while it also hopes to develop East Dawning as the local equivalent. Casual dining for China’s emerging middle class centers on their Pizza Hut brand, and Little Sheep Hot Pot may become the go-to casual dining restaurant for those seeking a more local experience. I wouldn’t be surprised if Yum! partners with other local chains as it continues to develop; however, for now it is clear that the three pillars of success are working well for Yum! Brands in China.

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Creating a company is hard, but creating a market is harder. The China Observer recently looked at how companies such as Proctor & Gamble and Campbell’s Soup were doing just that in China. KFC, now part of Yum! Brands, had to do the same thing in China, creating a market for Western fast food that did not previously exist. Since KFC’s initial entrance in 1987, others like McDonalds have followed – but none can match the successful operational model Yum! Brands has implemented in the Middle Kingdom. Yum! Brands success rests on the three key pillars of KFC, Pizza Hut, and increasingly local investments.

Pillar I: KFC – Western Fast Food For the Masses with Chinese Characteristics

KFC is Yum! Brands’ channel to reach China’s mainstream consumers – offering a combination of foreign flavor with localized tastes, and all at reasonable prices. In an interview with Warren Liu, former VP of Yum! Brands Greater China, he told me, “KFC has been positioned in China as a Western brand, even an American brand, with Chinese characteristics – a conscientious decision made at the beginning of KFC’s initial entry into China in 1987. Over the years, KFC China’s branding strategy has been modified through product localization and differentiated marketing practices. While McDonald’s entered China in 1990 and has remained a distinctively American brand since, KFC’s success can be attributed greatly to the fact that it has re-positioned itself over time as a foreign brand with local characteristics. From an advertising perspective, specifically TV advertising, the divergence in branding strategies is rather pronounced. While McDonald’s continues to focus on the young and hip by placing emphasis on individual expression, relying on young sporting stars and pop stars as brand spokespersons, KFC expanded its target market focus to include family and friends of all age brackets, reflecting its business volume growth and brand maturity in the process.”

Pillar II: Pizza Hut - Western Casual Dining for the Middle Class Urban Consumer

Contrary to what you may be accustomed to in the United States, Pizza Hut in China offers a radically different dining experience catering to Chinese white collar workers by providing high-end casual dining. According to this article, “Pizza Hut is the cheapest of the cheapest restaurants in the United States, but in China, Pizza Hut is seen as a classy, up-scale place for dining.”

There are multiple excellent articles that have been written on Yum! Brands success in China with KFC and Pizza Hut (like this one), but I would like to focus the remainder of this article on the local brands Yum! Brands has been incorporating into its restaurant portfolio.

Come back for Part II next week…

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I spent this past weekend writing an in-depth post about Yum! Brands influence and operating model in China. I was just about to publish it, when I came across this fantastic interview from Tom Doctoroff. The interview originally appeared in the Chamber Eye, the magazine of the British Chamber of Commerce in China, and was republished in The Huffington Post.

Doctoroff answers the following questions:

· How would you define the Chinese Middle Class, who are they, where are they and when did they emerge?

· How is the Middle Class growing in China and where is growth strongest?

· How do the Chinese Middle Classes view themselves?

· What are the challenges facing the Chinese Middle Classes?

· How are the Chinese Middle Classes evolving?

· What are the aspirations of the Chinese Middle Classes, what do they want?

· How does the State view the Middle Classes and how is the State providing for them, are they hindering or helping them?

· Is there a difference in how Middle Classes live at home and in Public and if so, why?

· What products and services do the Middles Classes aspire to have? Growth in home ownership, DIY, car ownership etc

How can companies reach out to the Chinese Middle Classes and connect with them? Examples of successes and failures?

“Success in China is rooted in having insights that uncover fundamental motivations and bringing your product in alignment with these. Every product that charges a premium needs to be a tool for social advancement.

Examples of success would be De Beers diamonds, in ten years of entering the market, the penetration of diamond engagement rings has gone from 8% to 80%. They were able to do this by understanding the motivations; marriage in China is different then it is in the west, in the west we like to believe that passion and romance will last forever, in China, however, it is commitment that lasts forever, not love as such. De Beers sold themselves as giving the Chinese man a tool to demonstrate his reliability.

Ford is another example that is doing better than everyone expected. It does not sell itself on how good it is to drive its cars, but by how they can transform people’s lives. Of course it depends on the model and which societal class you belong to, but fundamentally the allure is how the cars will help you to advance up the hierarchy in some shape or form, this in fact is why China has overtaken the US in the growth of automobile ownership, not because the Chinese need cars, but because it’s a threshold of middle classness - companies who want to succeed in China need to bring their products in line with the Chinese world view and structure of Chinese society.

Rejoice Shampoo, from P&G, has also done a very good job at maintaining its position within the market, it has done this through its ‘confidence through softness’ advertising, i.e. that the beauty of your hair will be noticed by other people.

Häagen-Dazs moved to outdoor consumption as they knew this was the only way to get people to pay the premium on their ice cream, it’s a great way for a boy to impress a girl by taking her to eat at such an exclusively expensive indulgent venue. Starbucks is doing much the same thing.

In China the product is a means to an end, the message driver has to be that this product will make you noticed and help you on your journey upwards.

The Chinese have no excuse to be buying luxury goods, given their level of income, but luxury is so externalised it enables inconspicuously conspicuous consumption, i.e. to show off without being seen to do so. There is a craftsmanship to selling products in China, it’s communicating how your product will help the owner solidify their status, but avoiding clichés.”

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China’s consumer confidence has reached record levels this past quarter. According to a joint study conducted by China’s National Bureau of Statistics (NBS) and Nielsen, China’s consumer confidence in Q1 2010 has reached levels not seen since 2007 . I am often skeptical of the figures reported by NBS, however this does fit with the trend of growth in China fueled by government spending and domestic consumption. Within the Chinese consumer market, I would like to focus on one group in particular, the luxury consumer market.

China is currently the fastest growing and second largest luxury goods market in the world, second only to Japan. It is expected to reach the number one spot by as early as 2015. In 2009 Chinese consumers purchased 27.5% of the world’s luxury goods at a total of 9.4 billion USD, in comparison to 2004 when their total was only 2 billion USD. The rate at which China’s luxury market has grown is tremendous, and China is now home to both the world’s second largest diamond market and the number one automobile market.

My recent interview with McKinsey’s Asia Consumer Director Vinay Dixit, highlights one of the key differences in China’s luxury consumer market – the relative youth of Chinese luxury consumers. He explained that on average they are roughly 20 years younger than their counterparts in the US, Japan and other developed nations.

Additionally, it is important to note that not all luxury consumers in China actually have the salary to support such purchases. China’s online message boards are filled with accounts of young Chinese white-collar workers who skip meals and only eat instant noodles in the evening in order to save up for a luxury purse made by Richemont or Louis Vuitton. Post 80’s generation Chinese refer to these individuals as “modern Madame Bovarys.” This type of Chinese luxury consumer lives beyond their means to attain a luxurious lifestyle like that of the main character in Gustave Flaubert’s famous novel.

Specific types of purchases vary depending on individual consumer’s tastes and preferences, but several trends emerge from the top consumer purchases. In general foreign luxury goods are preferred, with top purchases being automobiles, clothing, cosmetics, purses and watches. Despite the vast size of China’s luxury market, luxury goods consumption is relatively new in China, with consumers’ knowledge and behavior primarily driven by overseas brands.

Looking forward, much of China’s luxury market growth will continue to originate from cities outside of top tier metropolises like Beijing and Shanghai. In order to facilitate distribution and ease of purchase we can look for more e-commerce solutions. Websites like Taobao.com are often used by more price-sensitive consumers, however e-commerce in the luxury good sector correlates closely with convenience and access. For instance, wooha.com is a popular e-commerce site with a luxury-focused section selling Coach, Prada, Burberry, Cartier, Armani and others. This is just one example, but there will likely be others.

China’s luxury market is one of the world’s largest, and yet the luxury consumer population is only a small percentage the entire consumer population. Consumer confidence is at a high and the luxury market will continue to expand, but it is always important to remember that the majority of China’s consumers are still concerned more with solving 温饱问题 wenbao wenti or how to stay warm and adequately fed, rather than saving for their next luxury purse or watch. Nonetheless, luxury consumption is on the rise and will continue to be a key area to watch.

Inside Observer Intelligence: Richard from the excellent All Roads Lead to China blog provided us with the following insider perspective:

“In the past couple of weeks, I have met the GMs for a number of luxury brands in China, and all I can say is that they are smiling ear to ear.

There is a recognition that there is an imbalance/ paradox that is playing out here (i.e. there is a limited pool of people, but they are spending BIG), and groups are aggresively expanding to take what they can get while the gettin is good.

But, in each of these conversations, there is also something between the lines that they are not ready to say.. and that is that while people are spending now, there is a market saturation effect that is beginning to occur.. and that by going so far into the 2nd/ 3rd tier cities, there is a concern that they may cannibalize their 1sst tier city sales in the process.

It is not something that will stop anyone at this point, as many expect the next 3-5 years to be nothing but growth, but after that, nearly everyone I spoke with agreed that would be the timeline that proves the model.. or breaks the bank.”

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