China consumer demand: A four horse carriage

08 Jan 2019
  • Consumer demand drives China’s economy;
  • Fundamentals and structural changes are supporting growth and have a long way to run;
  • Innovative ‘new retail’ formats have the potential to propel further growth in the formal consumer sector.

China’s USD 4.9 trillion retail market1 took the lead as the world’s largest in 2016 and it is now at the heart of the growth strategies for global consumer products companies like Apple, Burberry, and Volkswagen.

China’s consumer is at the heart of the economy, contributing 53.6% of GDP in 20172, marking a dramatic rebalancing from 2009 and 2010 when exports and fixed asset investment dominated growth.

But there is still room for growth. At 53.6% of GDP, private consumption as a share of GDP in China still lags behind the 86.9% in the US, 84.2% in the UK3, and 77.6% in France3.

Policy support is lining up with recent tax cuts for low-income earners, tax breaks on education spending, relaxed rules on rural-urban migration, and roll-out of social services around the country.

China GDP growth by source, 2009-2017

Source: Bloomberg, CEIC, National Bureau of Statistics, November 11, 2018

Fundamentally, there are three ongoing drivers to propel consumer demand in the coming years:

  • Urbanization: an additional 242.5 million people are expected to migrate to China’s cities between 2015 and 20304, bringing millions of people into formal employment and bolstering what is already the world’s largest retail market.
  • Income growth: there has been a steady increase in disposable incomes during recent years, with 8.4% y-o-y5 recorded in H1, as workers transitioned to higher paying jobs in services sectors and labor markets tightened.
  • Lifestyle upgrades: China’s consumers are increasingly trading up for higher-quality, premium brands and services. There are a number of drivers for this, including increased incomes and desire for social status, and its driving demand in a wide range of sectors, including autos, home appliances, foods, high-end liquor, and clothing.

While the three above demand-side factors are fundamental to the long-term outlook, there is an important structural change playing out on the supply-side that offers growth opportunities in the future.

Sales of liquor by sales segment, 2012-2015, 2015-2017 (est.), and 2017-2020 (est.)

Source: Bloomberg, September 2017

Transition from unorganized to organized retail

Supermarkets, hypermarkets, 20186 and e-commerce outlets all make up part of the fast-growing organized retail sector, and this sector has a lot further to grow since approximately 55% of China’s grocery retail sector consists of traditional mom-and-pop stores and old-style, informal wet markets.

How China makes this shift toward organized retail in the coming years is a key part of the consumer story and the recent introduction of ‘New Retail’ formats is a trend that offers strong growth potential for companies leading the charge.

New retail basically means bringing the online retail management expertise and practices that propel China’s fast-growing e-commerce sector into the offline retail world.

China grocery retail: channel distribution,2016

Source: Bain & Company, How Brands Can Get Ahead of China’s Tectonic Shifts in Grocery Retail, September 20, 2017

That means applying the latest technology to improve in-store experiences, consumer choice, supply chain management, and delivery efficiency. Examples of ‘new retail’ approaches include:

  • Opening unmanned stores: where consumers visit, check out products, order via online systems, pay via mobile payment or facial recognition, and either get their products delivered directly to their homes, or have them rapidly delivered in-store.
  • Upgrading old capacity: renovating mom-andpop stores, supplying them with online ordering infrastructure, and adapting them to serve as delivery centers. These service upgrades give retailers updates on what products are selling well, special offers on new products, and closer, more efficient supply chain management.
  • Online tracking from beginning to end: all aspects of the purchasing cycle are recorded online, giving retailers detailed information on consumer preferences and buying trends, which can then be used to refine product offerings and improve supply chain and inventory management.
  • Rapid last-mile delivery: home delivery within 30 minutes of ordering marks a huge leap forward in order fulfilment even from two to three years ago, and drone deliveries offer new delivery options that can make last-mile fulfilment even more rapid.

Benefits
These aspects have clear benefits for consumers in terms of rapid delivery, cheaper prices, and convenience, but for companies the benefits are:

  • Reaching into untapped markets: new ways of tapping into unpenetrated, offline retail sectors, like groceries and fresh produce, make it likely that retailers can seek growth by monetizing retail channels and pockets of growth that are currently part of unorganized retail markets.
  • Much more detailed data on consumer behaviour: bringing consumer demand and ordering online creates a highly valuable flow of customer data that allows firms to understand demand more closely, and adapt product offerings to the market, and more efficiently manage inventory.

And initial data that compares order numbers at one leading new retail format store, Alibaba’s Hema, show a marked advantage compared to two established supermarket chains in China, indicating a strong response from consumers to new formats.

The transition to organized retail being driven by new retail formats that give consumers better experiences and promotes stronger competition is one aspect of China’s ongoing consumer story that has plenty of room to run in the coming years.

This transition, coupled with the strong underpinning outlook for fundamental demand drivers, will present excellent opportunities for investors in the companies that manage the infrastructure, i.e. IT platforms, and deliver the products, i.e. companies in consumer sectors, as China’s consumer story continues.

Daily retail transactions per store

Source: Alizila, New Retail Surges in China, may be roadmap for US retailers, June 1, 2018

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