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 / Autumn 2007 / Issue 48(originally published by Booz & Company)


Context and Complexity

Many global companies are setting targets for their China oper­ations that they can’t possibly reach without expanding beyond the biggest demand centers — Beijing, Shanghai, or Guangzhou, for instance — into second-, third-, or even fourth-tier cities. Doing this is not as easy as, say, expanding beyond New York and Chicago to Buffalo and Peoria. As you move into China’s second-, third-, and fourth-tier markets, you’ll find a steep drop-off in infrastructure, channels, management sophistication, and disposable income. Entering these new geographic markets can be intimidating to multina­tional companies. Many foreign ex­ecutives have never even heard of cities like Datong or Baoji, let alone had experience doing business there.

Although this state of affairs holds true for most emerging markets, China presents a market environment of exceptional complexity. Many people are already aware of the differences across China’s various geographical regions. However, few people understand the tremendous diversity even within regions, where there is significant variation between bigger cities and smaller cities and towns. Often just a 30-minute drive outside a large city takes you into a local economy that is far more modest and a commercial environment that is far less sophisticated. Complicating this situation is China’s breathtaking economic growth, which has transformed its major cities at a breakneck pace and has deepened the divide between these urban centers and the rest of the country. The speed of change, together with China’s size and diversity, makes it a market highly difficult to predict.

A consumer goods maker, for example, may be seeing great success selling in major cities, where the channels and distribution systems are fairly sophisticated and consumers have money to spend. But those population centers alone may not furnish enough growth potential to fulfill the expectations of many global companies; to really boost revenue, most companies are going to have to tap into second-, third-, and fourth-tier cities. That means that the company may need to introduce products or services better suited to the small city or rural demographic, sell them through more traditional channels, and cobble together a distribution network that can handle erratic terrain and a patchwork of customers. In short, they need different business models.

Companies entering China will also find a variety of evolving tastes to serve, as consumers get used to goods and even foods that they were unfamiliar with before. One example is milk. A decade ago, the only way Chinese consumers could buy milk was in powdered form because there was no suitable packaging to allow for transportation over long distance. As new packaging formats that employed pasteurization and ultra-high-temperature sterilization were introduced, the liquid milk market took off exponentially. Milk has now become a staple of the Chinese diet, especially among children. As a result, the Chinese dairy industry, led by companies like Mengniu and Yili, is very profitable and fast-growing today. One telling index to the industry’s success: Mengniu is now the single largest customer of Tetra Pak, the liquid packaging supplier.

Evolving Regulations
An enormously important element of the business context is the regulatory environment. We’ve found that too few business leaders really understand the regulatory context, and even fewer understand how it’s likely to change in the future. Although some outsiders may perceive that Beijing makes it very difficult for foreign companies to break into the Chinese market, the truth is that for the last 15 years, China has been quite progressive. That doesn’t mean that every industry embraces foreign competition, but compared to countries like Japan and Korea, which are still fairly restrictive toward foreign trade and business, China has been quite open. That’s especially true for such industries as fast-moving consumer goods, where the market is open to all participants and competition is very intense. Increasingly, the Chinese government is opening up its industries to more foreign participation, sector by sector and step by step.

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