Chinese Consumers: On Rocky Shoals but Not Shipwrecked

This is the first time in history in which a Chinese middle class of broad scale (125-150 million people) has confronted a global economic shock, begging the question of how spending behavior will - or will not - shift across a suddenly-altered economic landscape. Marketers hoping to counteract weakness in North American and European sales by relying on mainland consumers are bound to be disappointed. Newly-prosperous Zhangs and Lius will pull back spending and, in some cases, the impact will be dramatic. Overall, sales growth will halt and it may be some time before the PRC regains its position as an economic North Star. But the sky is not falling. The scale of wealth generated by economic reform has been colossal and the vast majority of Chinese still trust the central government to efficiently manage macroeconomic affairs. Once the mainland shopper reorients himself on the emerging landscape, he will re-open his wallet.

A bit of background....

A Tight-Fisted, Savings-Driven Middle Class. Any non-essential item has always been, and will always be, meticulously scrutinized for functional or emotional "value," limiting spending lunches in either positive or negative directions. China's middle class, approximately 125 million strong, has never been spendthrift. While penny pinched, savings rates are high, around 30%-35%. (The average resident of Tier I cities - Shanghai, Beijing, Guangzhou and Shenzhen - makes only 2,500 RMB per month, or $350. Although no official definition of the middle class exists, many companies start marketing non-essential goods such as small diamonds, premium ice cream and mid-tier restaurants to households earning around 5,000 RMB per month, or approximately $600, or $7,500 per year, versus nearly $50,000 per annum earned by the average American household.) According to home improvement retailer B&Q, the typical Shanghainese spends no more than $15,000 to fit out a completely "bare" 100-square meter apartment, covering everything from floorboards and appliances to paint and toilets.

Newly wealth individuals do not assume their money is safe. They have limited experience managing investments and they are not represented by the political establishment. Up to 90% of automobiles are purchased in cash, despite sticker prices that exceed an average buyer's yearly income. Mortgages do not exist without a 30% down payment. To boot, due to both infrastructural limitations and unease with "virtual transactions," credit card penetration - and, hence, credit card debt - is astoundingly low here.

The Protective Mass Market. Even more than the new middle class, the urban mass market has always consumed with great discretion. (China's consumer spending accounts for less than 35% of total economic activity.) They have always spent -- and will continue to spend -- only on essential or very cheap non-essential items. This is due to both the aforementioned protective instinct of all Chinese people as well as the lack of comprehensive welfare safety nets, modification of which will require structural - and, hence, long-term -- reform. Only 17% of rural residents have health insurance. Affordable housing is increasingly scarce. And, despite the central government's efforts to crack down on "miscellaneous" tuition and textbook fees, primary education remains a pay-as-you-go proposition for many residents outside primary cities.

Implications for 2009

So, what does this all mean? In a nutshell, the uncertainty unleashed by the global economic crisis will significantly impact Chinese already-conservative buying behavior over the medium-term but, long-term, the market will not collapse due to: a) the cushioning effect of high savings rates/low debt ratios and b) as discussed below, consumers' propensity to invest in "status goods" to gain face.

Big Ticket Purchases Suspended. The middle class is still not sure how the global recession will impact China in terms of middle class job stability, not to mention the prospect of lower prices at some point in the future. Until the medium-term outlook is less uncertain, the Chinese will revert to the naturally conservative buying behavior, deferring purchase of middle class "hallmark" items. Autos, for example, may have already driven off a cliff. Although consumers are still wending their ways through showrooms and dealerships, companies such as Ford and General Motors have relayed frightening anecdotal evidence of market retrenchment. Real estate purchases, too, have fallen dramatically for the simple reason that it is not the right time to buy. (A sagging property market will also hurt sales of related categories such bedding and furniture.) Foreign travel destinations will be hard hit as well.

On the bright side, transaction suspension will temporary, delayed until the coast is clear. We must remember that, to the Chinese, homes and Audis are not "luxuries," per se. They are prized markers of success. They qualify as entry into the ranks of the economically - and, therefore, socially -- empowered. Therefore, we expect to see an equally-dramatic spike in sales some time down the road - no one knows when -- as the country's economic stimulus package kicks in and the waves settle. (Unlike in the West, China has not experienced a housing bubble and auto penetration is only 3%, so the long-term picture is healthy.)

Limited Switching to Local Brands. There will be only modest switching between multinational, high-priced brands and cheaper local options. Premium priced items are rarely bought as indulgences but, rather, tools of advancement or "markers" on a journey to success. Therefore, consumers will be less apt to scale back within categories that allow status projection. In China, the golden rule of marketing is that buyers will pay a high price for goods that are used in public but save ruthlessly in privately-consumed categories. The leading mobile phones, boasting hefty premiums, are foreign. A Shanghai Yuppie, wouldn't be caught dead driving a local Chery, cheap price be damned.

Furthermore, in most categories, local companies price their products two or three times lower than multinational competitors, so switching options, unless one is willing to accept a major status hit, remain limited. The range of products (and price points) currently available is not broad enough to support a mad rush towards international goods, even in scary economic times. (And international luxury brands, cherished by youth not as shiny baubles but "status investments," have no local competitors.) Again, this will be particularly true for any products consumed out-of-home. Local brands in categories such as televisions, air conditioners and appliances may, in fact, benefit moderately at the expense of MNCs.

Trading Down within Premium Segments. Thus, middle class consumers will still buy publicly-consumed "show off" items. But they will limit risk exposure by "trading down" to lower-price tiers or switching to less expensive "display" categories, resulting in margin pressure for multinational corporations. In fashion, a man on his way up will buy Hugo Boss rather than Gucci. Or he might explore lower-priced sub-brands, shifting from Zegna to Zegna Sport and Armani to Emporio Armani. In spirits, the deal might be sealed with Johnny Walker Red, not Blue. On-the-rise drinkers may even trade down from cognac to premium beer but only in cases when the resulting "status sacrifice" isn't severe enough to preclude "landing the prize," whether it be a second date with a romantic target or a business contract. In mobile phones, the purchase cycle might increase from six to nine months but upwardly mobile professionals will still want to impress colleagues with stylish techno-savvy so they won't put off purchase of a new model for an extended period of time. Even some daily-consumed goods - high-quality shampoo, for example - are perceived to yield a public payoff. (For over twenty years, P&G's Rejoice shampoo has maintained category leadership with a "confidence from softness" position.) Unit sales, therefore, will be stable, although average price points will decline due to increased promotional sensitivity. Similarly, new generation types will still go to Starbucks to project cool but they will order a cheaper sandwich and switch from $3.50 vanilla latte to $1.75 cup of Americano.

Mass Marketing Stability. Finally, mass market spending, conservative in the best of times, will still not collapse. There will be no surge in unemployment in 2009 - low-wage, low-skill jobs here are relatively fungible, with workers laid off in one sector quickly absorbed in others - and no dramatic cutbacks in low-priced candy, milk, cheap beer, etc. The Communist Party's recent announcement of an intention to introduce a massive, $600 billion stimulus package will do little to alleviate a diffused anxiety of "losing everything" but it will prevent radical retrenchment and full-blown panic.

In Conclusion

In summary, Chinese have always been conservative spenders, but they pry open wallets for premium-price items that advance social and professional standing. The economic crisis will result in deferring, not eliminating, purchase of big-ticket items and squeezing value within premium segments without a rush to local, cheaper brands. Most marketers, therefore, can expect a protracted slowdown in sales growth and a hit in profit margins. That said, the bottom will not fall out of the market. Advertising and promotion spending should be sustained because the China market is not going to disappear. And, given the skittishness of most marketers, brands that continue to invest in strengthening equity - perhaps with messages rooted in "reassurance" -- will emerge from the crisis with a clear competitive advantage.

Comments

[PaPaPeng]

Bravo Tom. You got the Chinese consumer down pat. That's how I always conducted my affairs, getting the cheapest item that will do the job never mind the branding hype, paying in cash and eschewing debt except for big ticket items like a car or a home mortgage. (I live in Canada but never lost my Chinese habits.) Consumer spending in China will shrink a bit but not by much. On the same basis it will be futile for China's government or for Western economies to try to boost consumer spending in China and save the world. Your blog already said it all.