The China Observer: Where do you see foreign multinationals benefitting the most from a growing population of upper- and middle-class consumers? Are opportunities limited solely to tier-1 cities such as Beijing and Shanghai or is there a significant market opportunity in tier-2 and tier-3 cities as well?

Vinay Dixit: While the importance of key cities in tier-1 in China cannot be underestimated, significant growth will actually come from lower tier markets. In fact, we believe that almost 75% of new wealthy households will be created in areas outside the tier-1 cities in China.

The China Observer: It’s estimated that China’s Generation Y represents approximately 50% of the country’s current working-age population. Gen Y Chinese are relatively well-educated compared to previous generations and possess an optimistic nationalistic spirit that brands like Coca Cola, Adidas and McDonald’s tap into through their advertising campaigns.

Will luxury goods always come in the form of foreign-branded merchandise, or do you see a time when local Chinese luxury brands will be seen as attractive as their foreign counterparts?

Vinay Dixit: Our research reveals that in general, Chinese wealthy consumers place a significantly higher level of trust on foreign brands compared to those in the lower income brackets. However, there are marked differences on this trust level across the 7 need-based segments – from 23% to 80% who either agree or strongly agree to the statement, “I trust foreign brands”. In this kind of scenario, there would be some opportunities to local brands to position themselves for luxury consumption.

Having said this, it is usually an arduous task to build the heritage, product excellence and service standards that would provide confidence to the wealthy consumers to actually start considering them in their purchases.

The China Observer: When people mention companies like LVMH, Richemont, and PPR SA in China, images of copyright infringed goods and other “shanzhai” merchandise come to mind. How does this impact consumer behavior? Are luxury consumers as likely to buy the genuine when they can find the copycat for a fraction of the price? Do you find that in order to avoid suspicion of wearing fake merchandise, affluent consumers will dress from head-to-toe in authentic luxury merchandise?

Vinay Dixit: Clearly, there are varying degrees of interest in buying “Shanzhai” or even fake products across various wealthy consumer segments as well as across product categories. Our research indicates that many consumers have deep desire for “real” (and very expensive luxury goods) despite high availability of (cheap) fake goods. There is a difference though between some wealthy consumer segments who will not think to buy fake and those who will comfortably mix the two. For example, over 90% the “Luxuriant” segment disagree with buying fake watches and jewelry, whereas the figure is only 42% for the “Down to Earth” segment.

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Vinay Dixit is the Senior Director of Asia Consumer Centers in McKinsey & Company and leads the Insights China by McKinsey service line. He joined McKinsey’s Shanghai office in February 2008 and has led several significant studies on Chinese consumers. His most recent publications include, “The coming of age: China’s new class of wealthy consumers” and “One Country, Many Markets – Targeting the Chinese consumer with McKinsey ClusterMap”.

The China Observer: You co-authored a report last year that found China will host the world’s fourth-largest number of wealthy households by 2015. Who are China’s luxury consumers? In terms of age dispersion, are luxury consumers relatively younger than their counterparts in developed markets?

Vinay Dixit: We define Chinese wealthy households with an annual income of RMB 250,000 and above. In terms of Purchasing Power Parity, this translates to US$ 67,000 annual income. Please refer to the slide below for ranking of countries in terms of wealthy households.

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.

The China Observer: The 2009 McKinsey Consumer survey emphasized that companies should no longer assume the existence of a homogenous “China market” and monolithic block of 1.3 billion consumers, adopting a one-size-fits-all China strategy. The survey introduces the “cluster map” approach to China market strategy. How will this alter the business models of foreign luxury companies trying to gain a foothold in China beyond tier-1 cities?

Vinay Dixit: The last decade has seen remarkable changes in China – those relating to consumer evolution, infrastructure development, income levels and consumption patterns, to name a few. Our research (based on 30,000 consumers studied across ~60 cities since 2005) clearly shows that a “city-cluster” framework is fast replacing the “city-tier” approach when it comes to targeting the Chinese consumers.  Several key attitudes are now becoming more and more consistent in a geography of 250-300 km radius around key cities, irrespective of the tier in which these cities are.

This has significant implications in both “where to play” and “how to play” decisions of the companies. It provides significant clues towards choice of geographic areas that companies could prioritize in their launch and expansion plans on one hand, as well as on how to customize their go-to-market strategies in these chosen geographies on the other. Ultimately, we believe that this framework can significantly support a prioritized, sustainable and profitable expansion of a company’s business in China

With respect to luxury consumers, we see significant differences in their profile and attitudes across various cities and regions in China. We introduced the concept of 7 wealthy consumer segments in our last years study – even within the tier-1 markets of Beijing and Shanghai, we see significant differences in composition of the wealthy consumers. The differences in other tiers and geographies are even starker.

“We’ve been in China since 1988. We’re only in about 14 categories. We lead all of them but one. But the spending per capita in China is only $3 a year on Procter & Gamble products. That compares to the United States, where we are in over 25 categories, and the per capita spending a year is $100.”

The above quote is excerpted from a recent interview with Proctor & Gamble’s CEO, Robert McDonald. McDonald’s ambitious plans for P&G call for adding 1 billion new customers over the next five years – that’s 200 million customers each year – or 500,000 new customers EACH DAY for the next five years. The vast majority of these customers will come from emerging markets, especially in China and India.

One of the things that interests me about China’s many markets and emerging markets in general, is observing Western consumer goods companies take a proven product from overseas and introduce it in an emerging markets with no prior knowledge of the products’ use or existence. I’m not talking about “reverse innovation” or “glocalization”, I’m talking about taking a product and literally changing consumer behavior to create a market for it.

For example, let’s look at P&G’s Pampers disposable diaper brand. P&G had a terrible time launching Pampers in China, because Chinese consumers simply did not see a need for disposable diapers. Between traditional cloth diapers and kaidangku, Chinese mothers felt that they had their babies covered. After P&G did some research to identify the winning qualities of a disposable diaper in China, they put their marketing machine to work:

“Pampers launched the “Golden Sleep” campaign in 2007, which included mass carnivals and in-store campaigns in China’s biggest urban areas. A viral campaign on the Pampers Chinese web site asked parents to upload photos of their sleeping babies to drive home the study’s sleep message. The response was impressive: 200,000 photos, which P&G used to create a 660-square-meter photomontage at a retail store in Shanghai. The ad campaign boasted ‘scientific’ results, such as “Baby Sleeps with 50% Less Disruption” and ‘Baby Falls Asleep 30% Faster’.”

Pampers now ranks number one in a product category that barely existed just a few years ago.

Campbell’s Soup is another great example with a slightly different twist. While Chinese are already big time soup drinkers, the majority of soup is homemade. The challenge for Campbell’s is to take existing soup consumer habits and prove that their canned soup is better tasting, more convenient to consume and more cost effective.

You created the market – here comes the competition…

(Keep a look out for: Creating New Consumer Markets in Emerging Markets Part II)

“Television – with its sound, color, movement, ability to “break through” clutter and forge a brand’s identity – is an indispensible tool in new, untamed markets. Despite the growth of mobile phone and Internet usage in the PRC, China is still a mass market…The thirty-second television commercial still rules, and contrary to conventional wisdom, it will continue to rule long after today’s young generation ceases to be the New Generation (137).”

This quote from Tom Doctoroff’s Billions: Selling To The New Chinese Consumer captures the unique and powerful commercial role played by television in China today. Chinese television still lacks addictive dramas like 24 and Lost and some companies continue to waste their advertising budget on over-delivery. However, the television commercial remains an effective means of enticing Chinese consumers to buy particular products.

According to this recent Adweek.com article, China is set to become the fourth largest global ad market in 2010, with spending on television advertising set to increase. Key facts from the article include:

· In 2009, total advertising spending in China grew by 19% to approximately $129 billion

· Spending on TV advertising for the year increased by 20%, led by companies such as Proctor & Gamble, Unilever and L’Oreal

· Last year the top-spending advertisement categories in China were toiletries, business and services, foodstuffs, pharmaceuticals and beverages

Let’s take a look at two television advertisements in the toiletries and beverages industries.

The first advertisement below commemorates the 20^th anniversary of Proctor & Gamble China. The 2-minute clip links a variety of P&G products ranging from its Olay skin cream, to Rejoice shampoo and Pringles potato chips. The segment does an excellent job of demonstrating how much P&G’s products have been incorporated into Chinese consumers’ lives – so much so that without prior knowledge of P&G the viewer may even mistake the company for a Chinese firm. (China Accessible Link - Tudou)

The second clip is Coke’s television advertisement in celebration of the 2010 Chinese New Year. Like P&G, Coke has done an excellent job over the years localizing its ad campaigns for the Chinese mass market. It effectively links its campaigns with Chinese holidays and selects the hottest pop stars to star in its segments. This particular advertisement takes viewers through a Chinese New Year’s Eve featuring the popular Taiwanese boy band Fahrenheit. We fast-forward through the family’s traditional 团圆饭 tuanyuanfan or Chinese New Year family meal, gain a quick glimpse of them exchanging 红包 hongbao or red envelopes stuffed with cash, but then there is a contemporary twist when the members of Fahrenheit, while separated at their respective families’ homes, reunite via live webcam chat to ring in the new year together. (China Accessible Link - Tudou)

In urban China, Gen Y is a group of exceptionally talented people. No other generation in Chinese history has received such high-quality education for so many people. Chinese Gen Ys are single children born under China’s one-child policy. According to studies such as those by Posten and Falbo of the Guttmacher Institute, China’s solo children perform significantly better academically than peers with siblings. These single children have grown up in traditional extended families (including four grandparents and two parents), under pressure since kindergarten to pass entrance exams. This means that the child’s educational performance has been a top priority for six adults.

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I read a fantastic article last week on the Advertising Age website entitled, “The Internet Does Not Rise Above Nations and Cultures.” The article, by @wolfgroupasia of the Silicon Hutong blog, takes a closer look at why foreign Internet companies in China fail. Wolf writes that through observing past examples (such as: eBay, Yahoo! & Google) we are able to see some common threads of why foreign Internet companies fail in China. Rather than attribute failure to external factors such as government interference and unfair competitive practices, Wolf makes the excellent point that most foreign firms adopt a similar failed approach, which he terms “T&T” or “transplant and translate”:

The standard practice of foreign online firms coming to China has been to do some cursory research, hold a big press conference announcing that they are coming to China, open an office, hire a large local staff, and with some modest degree of localization set out to do in China the very same business they are doing in their home markets.

After a brief period of success and accolades, the following situation occurs:

The numbers stop rising as quickly. Maybe they even start to decline. Steeply. A local competitor pops onto the scene who seems to offer little more than a clone of the foreign site, but with a few weird differences. Suddenly the buzz is gone. Users flock to the competitor, advertisers and media agencies stop returning calls, and global headquarters is starting to ask hard questions.

A Closer Look at the “Local Clone with Weird Differences”:

If we take a look at this recent Economist article introducing the top 10 sites on the expanding role of Social Media in our lives (ranked by total unique visitor) a clear irregularity pops out:

1. Facebook

2. Windows Live

3. MySpace

4. Baidu

5. Twitter

6. Orkut

7. Hi5

8. QQ

9. LinkedIn

10. deviantART

Three of the top 10 global sites, ranked by total unique visitors, are Chinese sites intended primarily for the Chinese domestic market. These are the sites with the longer shelf life, and they’re also sites that were created by Chinese, for Chinese, in China. Yes, with a total Internet population that exceeds the total country population of the United States, homegrown Chinese Internet companies can rely on the domestic market alone to achieve success.

As long as foreign Internet firms apply the T&T strategy to the China market, domestic Internet firms will continue to thrive without much competition from abroad. This is all fine if Chinese firms focus solely on China, but will these homegrown Internet companies develop the best practices to win overseas? Or maybe the right question to ask is - with a domestic market of such grand proportions, is international expansion even worth the effort?

I highly suggest reading Wolf’s full article on the Advertising Age website HERE

The latest battle over Internet freedom in China is playing out in an online movie that pits an armored blue beast and his band of antiauthoritarian rogues against a sinister force called Harmony that seeks to clean up the Web.

The video, called “War of Internet Addiction,” is a send-up of government censorship starring videogame characters that has become one of the hottest things on the Chinese Internet, epitomizing the unruly spirit that thrives on the Web despite an intensifying crackdown on free expression in China.

The 64-minute video consists entirely of footage shot in the virtual universe of “World of Warcraft,” a wildly popular online game from Activision Blizzard Inc. in which millions of players around the world do battle via magical avatars.

The movie’s plot centers on gamers’ frustration with an actual bureaucratic battle over regulation of the Chinese edition of the game, but its subtext is a broad, biting allegory of the fight against government Internet controls, peppered with allusions to a list of real-world conflicts in China over the past year. The Chinese version of World of Warcraft is licensed by Netease.com Inc. and is operated independently from overseas versions of the game.

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Google, the “do no evil” company, gained entry into the Chinese search engine market last decade by agreeing to ban search results on topics deemed sensitive by the Chinese government. To Google’s way of thinking, it could do more good for Internet freedom and the cause of human rights by working inside the country to create value for its Chinese users, employees, and business partners. To critics, Google was selling out its core principles to play in the world’s second largest economy.

“Google shot themselves in the foot without gaining the moral high ground.”

So it was a shocking turn of events on January 12 when Google announced it would pull up stakes in China unless the country agreed to stop censoring search. The precipitating event: an unsuccessful cyber attack from inside China attempting to burrow into the Gmail accounts of Chinese dissidents. Since the announcement, little has transpired publicly; the two sides are presumably negotiating.

Who are the winners and losers here? Has China been taught a lesson? Has Google been outfoxed? What can other companies learn from this collision of cultures?

Harvard Business School professor John A. Quelch and research associate Katherine E. Jocz have just published a case study, titled Google in China (Case 9-510-071), based on public sources, that delves into some of these issues. We talked with Quelch last week.

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In this recent post on The China Observer about where I see the most potential growth for businesses in China’s Internet space I wrote:

“Companies who wish to succeed in China’s Internet space would best stick to areas that focus on job creation and economic gain that do not overlap with broader social & societal challenges. The government actively promotes the online gaming industry and is a great proponent of e-commerce companies like Alibaba Group that connect people to do business and grow the Chinese economy, rather than connect them in a way to go against the government.

However areas such as Internet search, Social Networks and other online communication platforms will continue to be heavily monitored, regulated and even thwarted by the Chinese government due to the potential impacts such tools have on social interaction and unification.”

The following highlights key excerpts from Robert Olsen’s latest Forbes article, entitled “China’s Migration to E-Commerce”

· The China Internet Network Information Center said the number of internet users in the world’s most populous country jumped 28.9% in 2009 to 384 million, which is more than the entire population of the U.S.

· China’s online shopping sales rose to $36.6 billion last year and one of the reasons behind that growth has been that retailers have been able to help consumers feel more comfortable shopping online.

· Alipay has grown to become China’s biggest online payment company by processing more than 1 billion yuan ($146 million) in transactions every day. Alipay recently announced that it expects to surpass PayPal’s transaction volume within two years.

· Much of China’s e-commerce growth is being driven by younger buyers. China Market Research Group said that users in China between the ages of 13 and 28 spend 20 hours a week online on average, compared with 12 hours a week in the U.S.

With an Internet user population that out numbers the total population of the United States, effective electronic payment tools in place, and young consumers growing increasingly comfortable with online shopping – e-commerce in China will continue to be an area of immense growth in China’s Internet space.

Another Chinese New Year is upon us, and this year we transition into the Year of the Tiger. As Chinese businesses begin to shut down until the beginning of March 2010, we’ve stared at the eye of the tiger and risen to the challenge of figuring out the trends for this coming year…

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