FT.com

Two-Speed China Consumer Market Raises Retail Challenges

China’s market for fast-moving consumer goods (FMCG) now operates at two distinct speeds: slow and fast.

By Bruno Lannes, Wei Yu and Jason Ding

Published on September 27, 2016
min read


This article originally appeared on FT.com (subscription required). Yoghurt is flying off the shelves in China. The value of yoghurt sold in 2015 grew by more than 20 per cent. Meanwhile, instant noodles are suffering a slump. Consumers in China bought 12.5 per cent fewer containers of instant noodles in 2015 than they did a year earlier. It seems that China’s market for fast-moving consumer goods (FMCG) now operates at two distinct speeds: slow and fast. The engine behind two-speed China is the government’s official “new normal” policy, which is managing GDP growth at 6.5 per cent to 7 per cent, shifting focus from manufacturing to services and consumption, and pushing for innovation-led growth over investment-led growth. For example, as manufacturing jobs move to Bangladesh, Vietnam and other lower-cost countries, sales of products that traditionally cater to blue-collar workers—such as instant noodles and mass market beer—are plummeting. By contrast, products favored by the rising service sector’s white collar workers—pet food and yoghurt, among others, and premium products in most categories—are growing fast. We’ve been tracking China shopper behavior across 106 product categories for five years, in partnership with Kantar World panel, and our recent survey found dramatic new patterns emerging. On the face of it, China’s brands seem to be running in place. Total FMCG sales value hit a five-year low, the result of a drop in both the volume of goods sold and in average prices. For the first time in recent memory, average annual spending per urban household on FMCG barely grew in 2015 from a year earlier, expanding 0.8 per cent to Rmb7,800 compared to a growth rate of 2.8 per cent in 2014. At the same time, though, the country is enjoying double-digit growth in spending in such sectors as health and wellness, lifestyle, travel and entertainment. Consider that from 2011 to 2015, cinema revenues expanded by an average 35.4 per cent annually, international travel by 28 per cent and water purifier sales by more than 50 per cent. Also, while FMCG prices declined overall, the average prices for personal care products jumped 11 per cent in 2015, as many consumers traded-up, often to imported goods. Retail channels in China feel the two-speed scenario, too. Hypermarkets endured declining sales in 2015. Among the reasons for the unpopularity of hypermarkets: growing urbanization has reduced the attractiveness of a concept that requires consumers to travel relatively long distances to stock up for a week. But while hypermarkets suffered, convenience stores grew by 13.2 per cent across China, and e-commerce in the world’s largest digital marketplace maintained its strong momentum, with a growth rate that exceeded 36 per cent. Finally, we see China’s dual-speed consumer market is playing out in the continuing battle between foreign and local brands. In 2015, local companies continued to gain share over their foreign rivals on an aggregate basis. Sales by local companies grew by 7.8 per cent in the 26 categories we studied, while foreign brands’ sales declined by 1.4 per cent in 2015. There are a number of contributing factors that favor domestic companies. Local brands have a rapid, single-country-focused process for new product development. As a result, they can produce new SKUs without the need for “global alignment.” Many are led by first- or second-generation entrepreneurs, who typically can make and execute decisions faster than their counterparts in foreign companies. These advantages enable them to adapt quickly to new trends, a critical skill in these more challenging times. S’ee Young, a local shampoo brand that emerged in 2014, expanded its business last year by swiftly by selling silicone-free products that are regarded as damaging hair after prolonged use. Local companies also have embraced e-commerce faster than their foreign competitors. In snacking, Three Squirrels started four years ago as a pure online brand targeting the young generation with products such as nuts and raisins sold with cartoon-based advertising. It reached sales of Rmb2.5bn in 2015 and has ambitions to become the No. 1 snacking brand in China. Geographic growth is changing, too, according to our survey of China’s shoppers. Until now, a city’s tier was a major factor in the velocity of value growth, but now, growth across all city tiers is moving into the 3 per cent to 5 per cent range. So brands can no longer rely on a city tier to predict growth rates. Among Tier-2 cities, for example, a big difference exists between Nanjing and Dalian. On a regional basis, the Southwest grew the fastest, whereas the Northeast and Southeast saw the slowest growth in 2015. These trends can help FMCG companies not only better understand market directions but also determine which trajectory their brands are on—fast or slow—and how to set the right strategy for that trajectory. Even in the two-speed scenario, shoppers display predictable purchase patterns, and brands that outperform rivals invest the time to identify those patterns. The brands that are set to emerge as winners in two-speed China are taking specific steps to adapt to this major evolution in the FMCG market. For example, they’ll adjust their cost structure and operating model to increase agility, speed in decision making and execution, and above all, the ability to embrace the ways that digital is disrupting their categories. Cost and operating models have not been a focus for companies in China so far, but as growth slows in some categories and digital disruption affects all elements of the value chain, companies have no choice but to embark on a digital transformation, the extent of which will depend on how much their category is disrupted. Building digital capabilities in R&D, supply chain, marketing and sales is no longer optional. In addition, brands with the best odds of winning will adapt their route-to-market model in line with the dramatic retail changes and the deterioration of distributors’ economics created by the overall market slowdown and rising online competition. Similar to retailers, distributors are under financial pressure. Many are driven out of business or decide to switch to more attractive ventures outside of FMCG brand distribution. As a result, some brands are losing points of distribution in China, and they need to find cost-effective ways to recapture those points. As they do, they’ll focus on the faster-growth channels and invest selectively in the others. Building household penetration, defined as the percentage of households in a market buying a particular band in a given year, is the key to creating large brands. We anticipate that winners will take three proven approaches to boosting penetration: building on existing memory structures to get more shoppers to think about a particular brand as they shop, simplifying and rationalising product portfolios to focus on critical “hero” products that have the highest potential to win with shoppers and perfecting in-store activation at the point of sale to ensure superior visibility and distinctiveness. Digital activation is now required, too, given that Chinese shoppers spend an average of three hours per day on digital media. Meanwhile, brands that watch their penetration plateau or even decline will turn to a proven strategy for squeezing growth in those situations: they’ll create premium versions of their products to command higher prices. Chinese consumers who can afford to do so are trading up in everything from packaged water, where premium brand Ganten Baisuishan is gaining share, to beer, where foreign brands like Budweiser continue to be popular. No longer the hyper growth capital of the world, China now is settling into a new normal, with an FMCG market advancing at two different speeds. That means the rules for building winning brands are becoming trickier than ever. Read the article on FT.com (subscription required). Bruno Lannes and Wei Yu are Bain & Company partners based in Shanghai. Jason Ding is a partner based in Beijing. All are members of Bain’s Consumer Products practice.

This article originally appeared on FT.com (subscription required).

Yoghurt is flying off the shelves in China. The value of yoghurt sold in 2015 grew by more than 20 per cent. Meanwhile, instant noodles are suffering a slump. Consumers in China bought 12.5 per cent fewer containers of instant noodles in 2015 than they did a year earlier.

It seems that China’s market for fast-moving consumer goods (FMCG) now operates at two distinct speeds: slow and fast.

The engine behind two-speed China is the government’s official “new normal” policy, which is managing GDP growth at 6.5 per cent to 7 per cent, shifting focus from manufacturing to services and consumption, and pushing for innovation-led growth over investment-led growth.

For example, as manufacturing jobs move to Bangladesh, Vietnam and other lower-cost countries, sales of products that traditionally cater to blue-collar workers—such as instant noodles and mass market beer—are plummeting. By contrast, products favored by the rising service sector’s white collar workers—pet food and yoghurt, among others, and premium products in most categories—are growing fast.

We’ve been tracking China shopper behavior across 106 product categories for five years, in partnership with Kantar World panel, and our recent survey found dramatic new patterns emerging.

On the face of it, China’s brands seem to be running in place. Total FMCG sales value hit a five-year low, the result of a drop in both the volume of goods sold and in average prices. For the first time in recent memory, average annual spending per urban household on FMCG barely grew in 2015 from a year earlier, expanding 0.8 per cent to Rmb7,800 compared to a growth rate of 2.8 per cent in 2014.

At the same time, though, the country is enjoying double-digit growth in spending in such sectors as health and wellness, lifestyle, travel and entertainment. Consider that from 2011 to 2015, cinema revenues expanded by an average 35.4 per cent annually, international travel by 28 per cent and water purifier sales by more than 50 per cent.

Also, while FMCG prices declined overall, the average prices for personal care products jumped 11 per cent in 2015, as many consumers traded-up, often to imported goods.

Retail channels in China feel the two-speed scenario, too. Hypermarkets endured declining sales in 2015. Among the reasons for the unpopularity of hypermarkets: growing urbanization has reduced the attractiveness of a concept that requires consumers to travel relatively long distances to stock up for a week.

But while hypermarkets suffered, convenience stores grew by 13.2 per cent across China, and e-commerce in the world’s largest digital marketplace maintained its strong momentum, with a growth rate that exceeded 36 per cent.

Finally, we see China’s dual-speed consumer market is playing out in the continuing battle between foreign and local brands. In 2015, local companies continued to gain share over their foreign rivals on an aggregate basis. Sales by local companies grew by 7.8 per cent in the 26 categories we studied, while foreign brands’ sales declined by 1.4 per cent in 2015.

There are a number of contributing factors that favor domestic companies. Local brands have a rapid, single-country-focused process for new product development. As a result, they can produce new SKUs without the need for “global alignment.”

Many are led by first- or second-generation entrepreneurs, who typically can make and execute decisions faster than their counterparts in foreign companies. These advantages enable them to adapt quickly to new trends, a critical skill in these more challenging times.

S’ee Young, a local shampoo brand that emerged in 2014, expanded its business last year by swiftly by selling silicone-free products that are regarded as damaging hair after prolonged use. Local companies also have embraced e-commerce faster than their foreign competitors.

In snacking, Three Squirrels started four years ago as a pure online brand targeting the young generation with products such as nuts and raisins sold with cartoon-based advertising. It reached sales of Rmb2.5bn in 2015 and has ambitions to become the No. 1 snacking brand in China.

Geographic growth is changing, too, according to our survey of China’s shoppers. Until now, a city’s tier was a major factor in the velocity of value growth, but now, growth across all city tiers is moving into the 3 per cent to 5 per cent range. So brands can no longer rely on a city tier to predict growth rates.

Among Tier-2 cities, for example, a big difference exists between Nanjing and Dalian. On a regional basis, the Southwest grew the fastest, whereas the Northeast and Southeast saw the slowest growth in 2015.

These trends can help FMCG companies not only better understand market directions but also determine which trajectory their brands are on—fast or slow—and how to set the right strategy for that trajectory. Even in the two-speed scenario, shoppers display predictable purchase patterns, and brands that outperform rivals invest the time to identify those patterns.

The brands that are set to emerge as winners in two-speed China are taking specific steps to adapt to this major evolution in the FMCG market. For example, they’ll adjust their cost structure and operating model to increase agility, speed in decision making and execution, and above all, the ability to embrace the ways that digital is disrupting their categories.

Cost and operating models have not been a focus for companies in China so far, but as growth slows in some categories and digital disruption affects all elements of the value chain, companies have no choice but to embark on a digital transformation, the extent of which will depend on how much their category is disrupted. Building digital capabilities in R&D, supply chain, marketing and sales is no longer optional.

In addition, brands with the best odds of winning will adapt their route-to-market model in line with the dramatic retail changes and the deterioration of distributors’ economics created by the overall market slowdown and rising online competition. Similar to retailers, distributors are under financial pressure.

Many are driven out of business or decide to switch to more attractive ventures outside of FMCG brand distribution. As a result, some brands are losing points of distribution in China, and they need to find cost-effective ways to recapture those points. As they do, they’ll focus on the faster-growth channels and invest selectively in the others.

Building household penetration, defined as the percentage of households in a market buying a particular band in a given year, is the key to creating large brands.

We anticipate that winners will take three proven approaches to boosting penetration: building on existing memory structures to get more shoppers to think about a particular brand as they shop, simplifying and rationalising product portfolios to focus on critical “hero” products that have the highest potential to win with shoppers and perfecting in-store activation at the point of sale to ensure superior visibility and distinctiveness.

Digital activation is now required, too, given that Chinese shoppers spend an average of three hours per day on digital media.

Meanwhile, brands that watch their penetration plateau or even decline will turn to a proven strategy for squeezing growth in those situations: they’ll create premium versions of their products to command higher prices. Chinese consumers who can afford to do so are trading up in everything from packaged water, where premium brand Ganten Baisuishan is gaining share, to beer, where foreign brands like Budweiser continue to be popular.

No longer the hyper growth capital of the world, China now is settling into a new normal, with an FMCG market advancing at two different speeds. That means the rules for building winning brands are becoming trickier than ever.

Read the article on FT.com (subscription required).

Bruno Lannes and Wei Yu are Bain & Company partners based in Shanghai. Jason Ding is a partner based in Beijing. All are members of Bain’s Consumer Products practice.