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1. Summary of sector developments China’s retail sector is still in a relatively early phase of development, with full open policies only in effect from 2005. With the government’s focus on first developing manufacturing, the Chinese service industry, comprised largely of retail, began to modernize at a fairly late stage in the reform process, with the first modern supermarket opening in 1990. However, modernization has occurred rapidly. Since the 2005 reforms, China’s retail sector has become one of the most liberal sectors of the Chinese economy. After seeing modest growth in the pre-2005 period, foreign investment is now accelerating and international retailers have already secured around 3% of the market share. We expect this figure to increase rapidly as more foreign players enter and as those already in China continue to expand aggressively. Moreover, the retail industry in China is still highly-fragmented, with the top 100 retailers in China accounting for only 10.5% of sales. Therefore expansion through M&A has become an attractive option and we also expect concentration levels to increase rapidly over the next 5 years. This report will present a forward-looking perspective on opportunities and threats for international and particularly Europe-based retailers in China. In particular the focus is on hyper/supermarkets and superstores, which together account for over 90% of international retailers’ sales in China. Catering is excluded from the analysis. Opportunities: The market - China’s retail market presents a tremendous opportunity for international retailers and producers alike. The market - EUR 672 billion in 2005 1 - is estimated to be the world’s 7th largest, and is growing faster than any of the leading six at an average rate of 10.2% for the last 5 years. Europe-based retailers, who accounted for 44% of sales among the global top 250 retailers, are well-placed to take advantage of the opportunities. Moreover, as the Chinese retail industry further modernizes and consolidates, it will provide better opportunities for European producers to find distribution channels for their goods in China (one can imagine the difficulties associated with having to supply hundreds of mom-and-pop stores as opposed to one large chain). Food still accounts for the highest proportion of spending at 36% of urban household expenditure. However, this has been falling at around a percentage point a year for the last 20 years. Telecommunications and transportation have seen the highest increases in household spending, in particular, ownership levels of cars, mobile phones and computers have seen dramatic increases. Nonetheless, rapid urbanization of lower-income consumers will ensure that food sales remain strong in the years to come. Wealthy urban centres such as Shanghai, Shenzhen and Beijing were the first to host foreign retailers. Having established a solid presence, they are now beginning to move to second- and even third-tier cities as urbanization is contributing to a massive increase in urban populations. Cities such as Tianjin, Hangzhou, Nanjing and Chongqing have already become major centres of foreign retail activity. Thus far, Europe-based retailers have been successful. Of the 17 foreign retailers in China’s top 100, 6 are Europe-based, contributing to 32.8% of sales of foreign retailers in the top 100. This is more than any other group of retailers by country of origin. Recent reforms – Upon entry to the WTO China committed to a complete liberalisation of retail and distribution by Dec 11 2004, 3 years after accession. Despite a series of delays in implementation, the reforms were more or less realized by mid-2005 and foreign retailers are now permitted to open 100% foreign-owned stores and distribution networks. The new regulations have dramatically lowered entry thresholds such as those on registered capital, turnover and assets, and geographical restrictions have been lifted. More importantly, application procedures have been streamlined, with the power of approval of new stores
For the purposes of the report, EUR 1 = RMB 10
in some foreign retailers becoming the subject of discriminatory antitrust action. For instance. For a start. The Moscow supermarket venture ended in failure. there are also some encouraging signs that the retail sector will continue to enjoy it’s relatively liberalized status. which is actually the antithesis of what its name might suggest. with managers’ inability to match local consumer tastes cited as the main reason. but at the same time has positive disinflationary effects. Management know-how. starting in SE Asia. While the market shares of foreign retailers in China are far lower than in their home markets. Retail is furthermore a labor-intensive sector and as such also contributes significantly to local employment. Antitrust policy – China’s first comprehensive antitrust law is expected to be approved in 2007 and it will soon be followed by sectoral antitrust regulations. In order to help domestic firms withstand the entry of foreign competitors. such as in Moscow and Singapore. While market shares of retailers in China are too far below the thresholds in the current draft law to presume dominance. .Chinese retailers currently pose little. if any threat. retailers in some developed countries have been criticized by trade unions and manufacturer groups for contributing to unemployment in European manufacturing sectors. It is certain that multinational retailers are catalysts of international trade. Pilot overseas investment projects have already been implemented. There have been concerns among foreign investors that the law will primarily be used as a means to curb foreign dominance of domestic markets. Sourcing . which in the short-term leads to unemployment in uncompetitive sectors.Sourcing opportunities play just as. Therefore retail is unique in China in the regard that it is one of the only sectors where foreign players are able to compete on price. Some Chinese officials have stated that China “will not allow its retail sector to be dominated by multinationals”. in the long-term. However. and current regulations still discriminate against larger chains. rather than the central planning agency. the reform-minded Ministry of Commerce is the retail sector regulator. is lacking. the state has pledged financial support in the form of direct subsidies and soft loans from national banks. the sheer volume of goods procured in China for export nonetheless allows foreign retailers to exercise significant buyer power to negotiate favorable conditions with local suppliers.devolved to local governments producing a notable increase in transparency of approvals with clearer criteria and timeframes. the National Development and Reform Commission. a resource which is difficult to leverage effectively in overseas markets. if not more. Nonetheless. the Chinese government is determined to build national champions in the retail industry with the purpose of competing with foreign retail giants and venturing into overseas markets. growing consolidation in the industry could result. However. At the same time it should be noted that while sourcing from China has indisputably been beneficial for multinational retailers and for consumers in home markets. one can expect growing state-backed resistance as foreign market shares increase. However. there has been a significant amount of negative publicity in Chinese media on the exercise of vertical restraints by larger foreign retailers on their suppliers. foreign retailers have complemented China’s development strategy of bringing in management expertise. Potential Threats: Domestic retailers . China’s comparative advantage lies mainly in its low-cost workforce. 2. to international operators in overseas markets. However. important a role for multinational retailers as for the domestic market. it goes beyond the remit of the present report to analyze the economic costs and benefits of increased exports of consumer goods from China to Europe. it is still premature to construct precise forecasts based on the currently available data. Industrial policy – Thus far. It can be expected over the next 5 years that the leading SOE and private retailers will continue to test their abilities in overseas markets. and particularly the ability to appeal to an internationally diverse set of consumer preferences. Future development scenarios With the relatively late opening of China’s retail sector and entry of foreign investment. multinational retailers’ export volumes far exceed their domestic sales in China. though the gap will likely narrow in the coming years. In many cases.
Domestic retailers gain a solid foothold in SE Asia and turn to EU and US markets. 2) 3) 4) 5) . Domestic sales of foreign retailers exceeds sourcing volumes. New entrants and particularly aggressive M&A by market incumbents will be a key driver in expanding market share. driven by strong growth in disposable incomes. Approximately 70% of the global top 50 retailers have entered the Chinese market. As a result concentration levels will increase significantly. expansion of foreign retailers slows and market share grows gradually to about 5%. FDI slows and remains constant while approvals are more difficult to obtain and revalued yuan increases costs of investment in China. Sourcing volumes drop and imports of foreign-produced consumer goods increases due to revalued yuan. Most of the remaining 30% will likely following in the next 5 years. Leading domestic retailers. Due to lower expected future market growth. 2) 3) 4) 5) Scenario 2 Assumptions: GDP growth slows after 2008 Olympics to around 7% Yuan is revalued by 10% or more Domestic backlash against foreign investment and regulatory environment deterioriates Outcomes: 1) Total retail sales grows at 7% until 2010 due to lower consumer confidence and slower growth in disposable incomes. FDI in the retail sector accelerates as foreign retailers expand aggressively and more new entrants appear. Revalued yuan reduces cost of overseas investment. Market share of foreign retailers increases steadily to about 8%. Due to increased administrative resistance. Scenario 1 Assumptions: GDP growth continues at previous rates (9-10%) until 2008 No dramatic revaluation of the Yuan. although it continues to appreciate gradually Government remains supportive of foreign investment in retail Outcomes: 1) Total retail sales grow at an average rate of 9% until 2010. Revalued yuan makes further investment in China more expensive vis-à-vis domestic retailers and retailers accelerate acquisitions.the following trends are identifiable and will likely result in the following types of scenarios in 2010. under pressure from foreign competition. urbanization and population growth. begin expansion in SE Asian countries.
SWOT analysis of European and Chinese retail sector Europe Strengths Superior management. ability to obtain good store locations etc. operational processes. negative publicity Threats Foreign retailers winning market share Gradual abolition of government support Foreign protectionism (for those Chinese firms expanding overseas) - - . after-sales service and capital Ability to leverage global networks Localization provides better adaptability to local business environments Strengths Established local brands.) Rapidly modernizing. employment Poor understanding of foreign consumer preferences - - Opportunities Sourcing of made-in-China goods for global markets Sourcing of foreign-made goods for Chinese market e.g. business models. consumer preferences Weaknesses No global networks Less advanced operational processes. wine Large and growing Chinese consumer market Improving supplier quality Opportunities Large consumer base from which to base overseas expansion Proximity with and good knowledge of local manufacturers/suppliers from which to base overseas expansion JV partners good source of management expertise Improving supplier quality Improving infrastructure - - - - - Improving infrastructure Increasing transparency of regulatory environment Threats Government support for competitors Poor supplier efficiency Political backlash against foreign investment Economic nationalism. government relationships SOEs have government backing (financial support. trading networks. able to adopt international best practices through JV partners China - - Weaknesses Less familiarity with local business environment. clients and partners. business models SOEs driven by non-commercial goals i.3.e. suppliers.
foreign majority ownership is also prohibited if the store sells “different types and multiple brands from multiple suppliers. which are manageable for large retailers but much more burdensome to SMEs. mulching film. Current obstacles relate mainly to “soft barriers” such as red tape. Customs-related problems also remain a risk. also be attributed to the importance of geography and local networks in retail. it remains to be seen how policies in retail will shift as foreign retailers build bigger market shares.” Moreover. Policy recommendations to DG Trade: Negotiate in WTO or lobby Chinese government to lift ’30 store rule’. In addition. vegetable oils.has greatly helped to reduce red tape and ease local government concerns about the ‘invasion’ of foreign enterprises. Furthermore. several retailers have said that maintaining a local image –for instance by retaining a JV partner. edible sugar. central-level approval (not normally required) must be obtained for each additional outlet opened. i. if a foreign retailer opens more than 30 outlets. may be the main driver for this. Local partners can sometimes be instrumental in managing these complexities. Obstacles to trade and investment Despite the recent reforms which permit 100% foreign-owned retailers. Lobby Chinese government to further clarify or abolish the city planning requirement. Most prominent is the ’30 store rule’. processed oil. Retailers which sell a large amount of imported goods will be particularly affected by this problem.4. pesticides. chemical fertilizer. EU-China trade and investment in retail has been largely beneficial for Europe-based retailers. which imposes an ownership limit of 49% on firms with more than 30 stores in China. 5. Foreign investment in China’s retail sector is still encouraged by the Chinese government. A condition for the approval of new stores in the new regulations stipulates that foreign retail outlets must conform to local city planning requirements. Foreign retailers often complain about inconsistent valuation practices and delays in the release of goods. For instance. This can however. though political reasons. Policy recommendations by priority Thus far. However. China is a highly-diverse market. or cotton etc. grain. one large retailer pointed to the localization rate of staff. . Negotiate in WTO or lobby Chinese government to lift ban on foreign majority owned enterprises selling products with “multiple brands and multiple suppliers”. its own distribution networks. there still remain some significant regulatory restrictions which affect larger retailers. There also remain some barriers to retailing of certain products and the foreign majority ownership of stores selling these certain products2. Most Europe-based retailers in China have already exceeded or are close to exceeding this limit. which was crucial in convincing local governments that a new store would greatly aid employment in the area. irrespective of the type of products sold. The conditions grant a high level of discretionary powers to local authorities and may be abused in the event of a political backlash against foreign retailers as foreign market share increases. Retail by foreign majority-owned stores of printed media is also restricted. each province has its own local customer preferences. a separate set of governing regulations and its own local government to be lobbied. 2 Pharmaceuticals. which cause some alarm among foreign investors. and Europe-based retailers have been successful in entering the Chinese market at a relatively early stage and building a market share. Finally. censorship. Negotiate in WTO or lobby Chinese government to lift product restrictions. which may help to explain why many foreign retailers have opted to continue business with their local partners.e. rather than hard ones. See annex 2A of China’s WTO Accession Protocol for details.
Enhance Customs reform to ensure uniform implementation of the WTO Customs Valuation Agreement. .Negotiate in WTO or lobby Chinese government to fully implement transparent. and reduce Customs formalities. This may be achieved through the Trade Facilitation negotiations. nondiscriminatory regulations and approval procedures for majority foreign-owned retailers.
Selection of findings from the industry survey (provisional) Figure 1: How important is the China market for your business in terms of sales? 70% 60% 67% % of responses 50% 40% 30% 20% 10% 0% 34% 22% 11% 11% 0% Today 22% 11% 0% In 5 years 3 moderate importance 22% 1 little importance 4 significant importance 2 some importance 5 utmost importance Figure 2: How important is China as an investment destination? 50% 44% 33% 34% 34% % of responses 40% 30% 20% 11% 11% 10% 11% 11% 11% 0% 0% Today 1 little importance 4 significant importance 2 some importance 5 utmost importance In 5 years 3 moderate importance * DISCLAIMER Please note that that the executive summaries of several sectors of the study on the future opportunities and challenges of EU-China Trade and Investment relations of DG Trade being carried out for the European Commission are preliminary results. the Commission accepts no responsibility or liability whatsoever with regard to the information in the summaries or for any losses or damage resulting from the information being quoted or used in any other manner.6. Therefore. .
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