By Andreas Fried & Aditya Chinnareddy, Universal Consensus
The fortune of the world is increasingly governed by development in China. In 2010 China overtook the U.S. in areas such as manufacturing output, energy consumption, car sales, and patent granted to residents. For most Americans, it’s very difficult to comprehend, let alone accept, how close China is to actually overtake the U.S. as the world’s leading economy. GDP in China is estimated to overtake the U.S. by 2018.
Given the increased importance of the Chinese economy, staying on top of these trends is now of paramount importance. Let’s look closely at three key trends:
One of the single most crucial long-term issues which frame the opportunity in China is its age structure. The “one-child policy” enacted in 1979 is finally catching up with China’s population growth. Although it has put a firm stop to impending over-population, it will create a huge age imbalance in the coming decades. People above the age of 60 now represent 13.3% of the total population, up from 10.3% in 2000 (see chart). In the same period, those under the age of 14 declined from 23% to 17%. Combine this with a bias in favor of male offspring that has left China with 32 million more boys under the age of 20 than girls, this demographic shift will create an insufficient labor pool, driving up the minimum wage, and creating an inordinate burden on the younger generation to support the older one.
While political strategy and economic policy is relatively easy to manipulate and quick to implement, the demographic structure of a country is obviously more difficult to shift and will run its course no matter what short-term changes are made to correct it.
This change will also put stress on the Chinese healthcare system, and in fact, this shift in the demographics creates one of the most substantial business opportunities in China over the coming decades. China, being a society with a strong culture of filial piety, is even less prepared than other countries to handle an aging population. What is referred to as the 1+6 rule stipulates that a one- child policy worker will have to support 6 people (2 parents and 4 grandparents). This is obviously a mammoth task and it puts an extreme pressure on people to succeed, spawning a highly competitive society.
Increasing Cost and Disposable Income
Another key trend is increasing production costs. Demographic trends play a large role in increasing costs. A survey released last month by the Boston Consulting Group relating to 106 large U.S. manufacturers, found that 37% of U.S. companies are actively considering bringing production back to the U.S. from China. 70% said sourcing in China is more costly than it looks on paper.
Some forecasts even estimate that outsourcing to China will be as costly as producing domestically in 2015 (including freight, exchange costs etc.). Although that estimate is open to debate, the reality is that costs are rapidly increasing. China now has the highest total labor cost in emerging Asia. A high inflation rate of 6.5% compounded with the 1+6 rule is pushing wages and costs higher. The wage increase is currently 30% on an annual basis. China’s currency is also slowly appreciating against the dollar, but this appreciation is likely to level out in the coming years.
While an aging population may have a detrimental impact on the Chinese economy, the fact that disposable income is rising is a very positive sign that China will continue its path of prosperity at least with regard to spending. As we will see in our case studies, Chinese consumers love fashionable items that increase status – sometimes referred to as “face consumption” – and this trend presents specific opportunities for consumption of luxury products, inbound tourism, U.S. university enrollment of Chinese students, and overall consumption. In the coming decade, China’s percentage of the world luxury goods market consumption will rise from today’s 7% to almost 20%. Total luxury consumption sales in China are already at $30 billion.
Many Western Companies Still Fail
Even though most multinational companies speak of the growth opportunities in China, only a few are currently profitable. Chinese consumers, like most consumers, can be fickle. There are few guarantees that a business model that worked in the U.S. will work in China. As a matter of fact, many major American companies have failed in their China expansion.
A classic example is Best Buy, the American electronics retailer. Best Buy closed its nine branded stores in China in 2011, after five years presence in China. The Best Buy business model is to purchase all of its products directly from suppliers and price them independently. They also hire their own staff and sales team and utilize a non-commission based compensation plan in order to avoid biased promotions that will disturb customer decisions – a very acceptable model here in the states and certainly one that has the best interest of the consumer in mind.
The Chinese business model for electronics is that they lease separate parts of a store to retailers of distinct brands and earn profits from the so-called “entrance fee” and take a portion of every retailer’s sales profits.
Best Buy’s decision not to glocalize and adapt its business model to Chinese circumstances led to the following mistakes:
And to top it off, Best Buy missed the entire point and identified price as the only purchasing-parameter of importance among Chinese customers.
Best Buy is just one example; others with a similar fate include Home Depot, Disney, Mattel, and Groupon. The common denominator among these and other failures have been lack of glocalization and failure to understand Chinese consumers and markets. Companies which have been successful, such as KFC and McDonalds, have instead made numerous adjustments to cater to Chinese customer and local market sentiments.