Strategic Overview: China and 2020

China and it’s place in 2020

If you are a luxury consumer, aspirational observer, student or currently pursuing a career within the luxury space or other please share your thoughts, criticisms, ideas and observations with us…

China. It’s the word that is on everyone’s lips at the moment. From the natural resources industry to the manufacturing industry through to retail, China is the place to be. If you want to be a part of the boom that is.

The luxury industry has always had a reasonable presence in China, but in the last year, fashion houses have stepped up their presence in the country and are pushing their expansion plans full steam ahead to cope with the demand.

We reported in our Luxury and China report last year that Louis Vuitton, Zegna, Cartier, Dunhill and Ferragamo were particularly proactive in the initial stages of expansion into the region. And with the recent news that China were looking to soften their import taxes, this could be good news for both the luxury houses and consumers.

For those who haven’t already formed a presence in China, companies should rethink their strategy. Most large consumer-facing companies realise that they will need China to power their growth in the next decade.

But it’s not about making hurried decisions which may see the experiment fail. To understand the Chinese market, companies need to research. They need to research the target market, importing, the financial viability and taxes. The companies also need to understand the economic, societal and demographic changes shaping the profiles of consumers and the way they spend. This is no easy task, not only because of the fast pace of growth and subsequent changes in the Chinese way of life but also because of the vast economic and demographic differences across the country.

To get a grasp on China, an understanding of the consumer’s habits is essential. One needs to get into their psyche and see what makes them tick and spend dollars. Chinese consumer’s movements and habits are constantly moving, similiar to the industry.

Despite the global downturn, the number of wealthy households in China continues to grow. It has been reported that by 2015, the country will hold the world’s fourth-largest concentration of wealthy people. The number of China’s wealthy households, which hit 1.6 million in 2008, will climb to more than 4.4 million by 2015, trailing only the United States, Japan and the United Kingdom in sheer size.

McKinsey has released a report casting their predictions of the Chinese consumer of 2020. Not only has McKinsey channelled their thoughts into the future with consumers expectations in 2020, but Tourism Australia has also released a report forecasting visitor numbers from China to Australia in 2020. With over 60,000 people interviewed since 2005 in over 60 cities, the surveys have tracked the growth of incomes, shifting patterns of expenditure, rising expectations—sometimes in line with those of the respondents’ Western counterparts and sometimes not—and the development of many different consumer segments.

But our understanding of consumer trends to date, coupled with an analysis of the economic and demographic factors that will further shape them in the next decade, serve as a useful lens for contemplating the profile of the Chinese consumer in 2020 (McKinsey 2012).

To understand the Chinese consumer, luxury companies must understand the following.

Changing demographics

Many of the changes taking place in China are common features of rapid industrialisation: rising incomes, urban living, better education, postponed life stages, and greater mobility. Japan saw similar changes in the 1950s and 1960s, as did South Korea and Taiwan in the 1980s. We believe it was only a matter of time before China rose to power and put themselves in the current situation.

Changes in economic profiles have been and will continue to be the most important trend shaping the consumer landscape. The Chinese are certainly getting richer fast: the per-household disposable income of urban consumers will double between 2010 and 2020, from about $US4,000 to about $US8,000. That will be close to South Korea’s current standard of living but still a long way from its level in some developed countries, such as the United States (about $US35,000) and Japan (about $US26,000). The current vast differences in income levels will persist, however, although the numbers at each level will shift dramatically. At present, the great majority of the population consists of “value” consumers—those living in households with annual disposable incomes between $US6,000 and $US16,000 (equivalent to 37,000 to 106,000 renminbi), just enough to cover basic needs. “Mainstream” consumers, relatively well-to-do households with annual disposable income of between $US16,000 and $US34,000 (equivalent to 106,000 to 229,000 renminbi), form a very small group by comparison. China has fewer than 14 million such households, representing only 6 percent of the urban population. A tiny group of “affluent” consumers, whose household income exceeds $US34,000, accounts for only 2 percent of the urban population, or 4.26 million households. Because the wealth of so many consumers is rising so rapidly, many people in the value category will have joined the mainstream one by 2020. Indeed, mainstream consumers will then account for 51 per cent of the urban population. Their absolute level of wealth will remain quite low compared with that of consumers in developed countries. Yet this group, comprising 167 million households (close to 400 million people), will become the standard setters for consumption, capable of affording family cars and small luxury items. Companies will be able to respond by introducing better products to a vast group of new consumers, thus differentiating themselves from competitors and earning higher profits.

Affluent consumers will remain an elite minority, making up only 6 per cent of the population in 2020, translating into about 21 million affluent households, with 60 million consumers. While income is expected to rise across China, some cities and regions are already significantly wealthier than others. Today, about 85 per cent of mainstream consumers live in the 100 wealthiest cities; in the next 300 wealthiest, only 10 percent of consumers are mainstream, but that percentage will rise to nearly 30 per cent by 2020. At that point, many families in these cities will be able to afford a range of goods and services (such as flat-screen televisions and overseas travel) that are now largely confined to the wealthiest urban areas. But it’s worth noting that the affluence of their populations could make them as attractive to companies as leading tier-one cities, such as Shanghai and Shenzhen.

New spending patterns

An understanding of China’s changing economics and its impact on the profiles of consumers helps to identify some key trends in spending patterns in the next decade.

Higher discretionary spending

Discretionary categories will show the strongest overall growth—13.4 per cent—between 2010 and 2020, as these goods become affordable to growing numbers of consumers. Next come semi-necessities (10.9 per cent growth) followed by necessities (7.2 per cent). These average figures will of course vary significantly by region and city. The wealthiest people—those in our affluent segment—will be the main consumers of discretionary items.

Aspirational trading up

The second noticeable trend in spending is a propensity to trade up, driven increasingly by consumers aspiring to improve themselves, the way they live, and their perceived social standing. Many Chinese, like their Western counterparts, judge themselves and others by what they buy. It is the top end of the market that will benefit most from trading up: growth at the high end of some consumer goods categories already outpaces average growth for those categories as a whole. Sales of premium skin care products, for instance, rose by more than 20 per cent a year in the past decade while the industry average was 10 per cent. Annual volume growth rates of more than 20 per cent are foreseeable for luxury SUV cars, compared with around 10 per cent for basic family models. China had already become a leading luxury market by 2010 and could overtake Japan to become the biggest such market by 2015.

Emerging senior market

The aging of China means that as a share of the total population, it will have five percentage points more people above the age of 65 in 2020 than it has today. That is an extra 126.5 million citizens, clearly an important consumer segment. The spending patterns of elderly people will differ in 2020, compared to today. In McKinsey’s 2011 survey, the elderly were more inclined to save and less willing to spend on discretionary items such as travel, leisure, and nice clothes. The elderly aren’t a definitive target market for the luxury companies, with them looking towards early adulthood and middle age citizens, where disposable money is more evident. The MO Luxury’s Australian Luxury Report, 2011 reaffirmed that with Boston Consulting Group reporting that consumers between 30 and 50 years old are considered to be the primary consumers. McKinsey (2009) reports that while 30 per cent of the American wealthy consumers are under 45 years old, they represent 80 per cent in China (18-45).

What typifies the current Chinese luxury consumer? Urban, educated, 20- and 30-something office workers (average age around 27 years old). Unlike their parents, this group of individuals — broadly, but not completely, female — has no compunction about spending most of their paycheck on conspicuous luxury products they really can’t afford.

Implications for companies

The biggest challenge is building and sustaining a leading position in China and, for multinationals, using it to drive global growth. A second challenge is that China is so vast and its regions so diverse it should be treated almost as a collection of separate countries. Companies should redefine the roles of their regional divisions and headquarters, delegating more decision-making power to the former. Many companies already operate with three, five, or even more regional bases, but these tend to function only as sales offices, executing instructions from the top. A third challenge stems from the fact that undifferentiated mass consumption and the rising cost of ads made the scale of a brand or product crucial to its success in the past decade. Companies provided the same value proposition—usually framed around a product’s functional benefits—to all types of consumers, while stretching brands across product categories and price tiers to leverage scale and garner market share.

Whilst it is has been speculated and reported that luxury growth is exepected to slow down this year after a heroic effort in 2011, the luxury companies must integrate with the local consumers in a bid to whet their appetite. No doubt China and its consumers’ behavior will take some unexpected turns over the next decade. To be sure of taking part in that journey, companies in the market should start making the acquaintance of China’s 2020 consumers today and not a day later.

Cassandra Murnieks

image credit: chinastockdigest.com