First, second, third and fourth-tier cities

A May 2018 report by Morgan Stanley asserts that the future of China’s growth (by 2030) will lie within lower-tier cities (namely the third and fourth-tier). It is more and more common to see economic analyses regarding China make use of this urban classification. While being a useful analytical tool to understand China’s society, the definition of tiers is actually not so obvious and requires that we stop for a while and think about it.  This article thus gives you the keys to better understand this aspect of China, and the resultant opportunities for your businesses.

A ranking of cities

To begin with, there is no official definition of what is a first, a second, a third and a fourth-tier city in China. To give you a general idea, Beijing, Shanghai, Shenzhen and Canton are unanimously classified as first-tier cities, while second-tier cities are generally provinces’ capitals. Yet, some rankings would label Suzhou and Wuxi as second-tier cities because of their economic growth and despite the fact that they are not capitals. Similarly, Hefei, the capital of Anhui province, is sometimes categorized as a third-tier city because of its weak domestic growth. Three-tier cities generally include non-capital cities with a dynamic economy (high economic growth rate). Lastly, fourth-tier cities are important cities in terms of their population size, but which economy is not so flourishing.

Each year, Yicai Media Group’s Rising Lab issues a ranking of the Chinese cities in terms of tier and make part of their methodology open to the public, allowing us to take a look at their criteria (Yicai Media Group is one of the first economic media in China). They use five criteria: the density of commercial resources, the degree of transportation’s connectivity (is the city a hub?), urban residents’ habits (to what extent do they use e-commerce?), the diversity of activities available in the city and the degree of visibility into the city’s future (the real estate market, the fluidity of the road traffic, the pollution, the talents’ attractiveness, the entrepreneurial index…) Be aware, classifying a city in a first, second, third of fourth-tier is likely to have a tangible impact on the city’s real estate price…

Thus, each organization speaking about tier cities is likely to have their own and different criteria. Most criteria revolve around the local GDP, the population size, and the administrative status of the city (whether it is a province’s capital or not). While the type of criteria does not vary so much from a report to another, the way it is measured does, inducing porous frontiers between different tiers: some cities can be classified in different tiers. Furthermore, the denomination “lower-tier cities” technically encompasses second, third and fourth-tier cities. This can be misleading since second-tier cities are generally wealthier than the average Chinese city.

Another limit in this definition is that very different realities are described with the same word. Indeed, second-tier cities include industrial cities (Tianjin, Wuhan, Changsha…) coastal cities whose consumption market is more developed (Nanjing, Hangzhou, Wuxi, Suzhou…) as well as inland cities, often industrial but that are also becoming hubs with the One-Belt-One-Road initiative (Chengdu, Chongqing…)

A map of consumers

Despite these limits, knowing the tier of a city still is useful as a reading grid to understand to some extent the geographical diversity of China. Morgan Stanley’s report is an illustration of it, identifying a 6,9 trillion USD potential for growth within third and fourth-tier cities by 2030. They identify more specifically five city-clusters with high growth potential: the Jing-Jin-Ji region, the Yangtze River delta, the Canton bay, the Mid-Yangtze region, and the Chengdu-Chongqing area.

They support this assertion by several arguments, the first one being political support for growth in these very cities. Indeed, the central government and regional governments have been recently issuing many development plans, respectively inter-regional and intra-regional, allocating wide investments in connectivity infrastructures. As a result, there has been a multiplication of high-speed trains connections which divides the travel time by two and helps dis-enclave cities.

Besides, the cities offer financial allocations to help young talents buy real estate properties, a must do after graduation in China (this refers mainly to second-tier cities which have the financial resources for it). Besides, contrary to first-tier cities (except from Shenzhen) who implement stricter hukou* policies in order to hamper their population’s growth, second-tier cities make the promotion of their hukou policies, easy to obtain for young talents. As a result, Morgan Stanley’s report forecasts a 2.5% annual urban growth in lower-tier cities between 2017 and 2030. Lower-tier cities also have a higher fertility rate which accounts for this higher growth, as life costs (and the costs of having a child) are lower than in Beijing or Shanghai.

For European companies, as well as for Chinese ones, this demographic evolution means that lower-tier cities, especially second-tier cities, will gather an increasingly qualified manpower as well as better infrastructures in the near future. Implementation costs are to decrease, while labor costs are increasing on the coast. Chinese and foreign companies already started to move in these inland cities (cf VVR’s September article).

Another consequence of interest for European businesses lies in distribution. Indeed, more and more retailers are attracted to these new and untapped markets opening in these smaller cities, as they become more accessible and people’s incomes are increasing. Firstly, residents from these cities devote a larger part of their budget to discretionary spending as their fixed costs are lower (rents). Besides, although there is in these cities a smaller part of the population earning enough to afford European products (often more expensive and assimilated to rather high-end products), the quantities bought per consumer are comparatively larger than in first-tier cities. In other words, less people buy European goods, but the ones who do buy more of them.

Turning more specifically to these consumers’ habits, a survey by AlphaWise on more than 3000 households notes that the income gap between first-tier and lower-tier cities is reducing, but also that consumption habits changed significantly. Third and fourth-tier cities’ consumers now pay more attention to the value of the goods they buy: they upgrade their consumption and are increasingly sensitive to brands (mostly local brands for now). They also care about the fastness, quality and entertainment’s aspect of the service. In terms of industries, the sectors of daily consumption goods shall mostly benefit from these changes: house appliance, food & beverage (especially dairy products), beauty products and make-up… Most of this growth is also expected to happen within the e-commerce because of accessibility reasons. The entertainment industry (cinema, tourism) and the education industry are also likely to see some positive trends in their consumers’ pool.

There are yet some limits to this overall positive picture of the economic potential within lower-tier cities.   Firstly, today, the costs and risks of implementation in third and four-tier cities are still rather high: quality retail spaces are still few, and the size of the consumers’ pool remains to be verified. Thus, it is recommended to use e-commerce to test these markets (although this retail channel also bears its own limitations, cf VVR’s July article).

Furthermore, third and fourth-tier cities’ consumers might have a similar spending power as in the first and second-tier cities, this does not mean that they have similar consumption habits: it is crucial to analyze accurately the local consumption habits and to not launch a product merely because “it worked well in Shanghai”. Each expansion strategy must be thought locally and a dose of education on international products (on geographical indications for instance) might very well be necessary.

Lastly, the consumption’s growth in the lower-tier cities is conditional upon regulatory changes, especially regarding the real estate market. Indeed, these cities’ attractiveness relies on their low real estate prices, enabling young households to buy property. Besides, these young households’ budget is also less taken up by rent and more is available for consumption. On that point, there is no study that is today forecasting such a change in the near future.

In short, China has diverse markets, and it is important to understand their local specificity. Tiers are one way to approach diversity and allows for the above analyses. It is then one way, but it is not the only one and it can not account for the entire diversity of China. For instance, it is also important for retailers and employers to understand the different generations in China…

* The hukou is a resident permit that each Chinese citizen gets, binding them to a province (Shanghai’s hukou, Beijing’s hukou, Jiangsu’s hukou). It is rather similar to a province-scale “nationality” and serves to obtain a right to some public services in the location of the hukou.

By Manon Bellon

Two stories about tea and dairy products

The conclusions of the governmental report that was released in May at the E-commerce Convention in Beijing came as no surprise: e-commerce transactions grew by 11,7% in 2017.

Several facts were as well underlined in this report: the outstanding development of the cross-border e-commerce (+120% in cross-border imports), the fact that online platforms and offline industries are increasingly integrated through the use of big data technologies, and the dramatic changes in consumption habits such as the use of mobile payment which increased by 44%. In other words, e-commerce is today one of the main distribution channels for consumption goods, when it is not the most important one.

This article thus explores how companies, especially in traditional sector (tea and dairy products), adapt to this new (online) normal. Their stories are not only inspiring for tea and dairy products’ companies, they are also characteristic of an essential asset companies must display on the Chinese market: the faculty to adapt.

Tea for the millenials

Tea is to China what wine is to France or beer to Germany, a part of their culture. Now is the time when the “Grands crus” arrive on the market, and some of them can reach several thousands of euros for a kilo of tea leaves (the price is determined by the region where the tea leaves are grown). Yet, tea is less and less affectionate by young Chinese. Besides, it is a challenge for the consumers to recognize a good tea from the taste, and even a bigger challenge to recognize it from the packaging, when buying one’s tea in supermarkets. Contrary to wine, price is not a reliable indicator of quality.

Recently, several tech companies saw an opportunity and came up with innovative business models in order to tackle these challenges: Xiaomi introduced Xiao Guan Tea, NetEase came up with Yanxuan, and Penguin Guide also launched their own tea brand. These undertakings seem at first daring as none of them had previous experience in the tea business where it does matter. Yet, Xiaoguan’s 700 millions yuan sales in 2017 indicates otherwise.

Indeed, these tech companies used their technology and innovative sales methods and adapted them in the tea market. They thus managed to improve and modernize the consumer’s experience, a decisive feature in a brand’s success say all the recent consumers studies in China. For instance, selling on e-commerce platforms gave them a reach to the post-90s consumers, and it simplified the purchasing act for the consumers.  Reaching the post-90s is primordial in nowadays market as they become the driving force of the consumption market (McKinsey survey 2017). These consumers are now looking for high quality unique and traceable products, as well as to a lesser extent, other generations of consumers.

XiaoGuan also used the authority of height “tea masters” for marketing, which provided the brand with an image of know-how, guaranteed quality and uniqueness. The fact that the founder of the brand is himself originating from a traditional growing area surely helped: it brought a feeling of tradition, and a deal of personal history to XiaoGuan’s products.

The opening of offline shops completed this innovative strategy. Decorated by the Apple stores’ designers, these shops are the offline side (consumer’s unique experience) of the online sales (easy purchasing process).

All in all, in adapting their products to the new consumption loci and in developing a branding strategy, these tech companies could enter a traditionally rather close market with success.

Improve your knowledge of your consumers, personalize the consumers’ experience

Certain actors, already since long on their market, are also starting to use big data, such as Mengniu, one of the leaders in dairy products for around one century in China.  For Mengniu’s CEO, Jeffrey, Minfang LU, artificial intelligence is a tool for companies to use to improve their organization and their service to consumers (McKinsey interview, 2017). It is all the more necessary that digitalization of the commerce in China also creates several challenges for big traditional companies. Indeed, in the dairy products’ case, Chinese increasingly buy online and opt for home delivery. Consequently, they buy more often and in smaller quantities. They are thus more often choosing a product in a market that is also having a wider offer, and dairy products’ companies need to convince them more often, and through a different media for what it matters.

A national company such as Mengniu counts more than 20millions of “active” consumers, meaning that these consumers share voluntarily information about their preferences and their consumption habits on e-commerce platforms and social networks. For Jeffrey LU, these data are a goldmine to know how to improve their products and marketing. Yet, the company’s current resources are insufficient to treat all these data. One solution that was found is to cooperate with e-commerce platforms who already collect and analyze these data. For instance, Mengniu has a project with Alibaba to analyze their supply chain and determine where to produce, and how to improve their transportation network to gain in efficiency. Mengniu’s teams also analyze consumers’ data in order to design more personalized products, which the consumers are now looking for.

Lastly, market digitalization is not only an opportunity for companies to gather more data about their consumers, it also opens a new communication channel where they can rather directly reach these consumers. Chinese consumers want healthier products with a better traceability, information that a firm like Mengniu can easily provide as it disposes of data on all their farms and even on their cows. Thanks to nowadays data technologies, Mengniu has the capacity of taking up an informative role towards their consumers, not only providing them with information on the products, but also on the nutritional values of dairy products. Jeffrey LU also sees an opportunity to build a story around their milk: “We are not just a milk manufacturer telling you what we can do; we want to be part of your life.” as he says.

Hence, these two stories illustrate the trends of the markets, and the changing expectations from consumers, whatever the sector, and how companies can deal with that. The tea companies showed innovative capacity and put in place a new business model that seems successful in a market in needs of modernity. Regarding the dairy products industry, Mengniu managed to take advantage of their great pool of data to answer requirements from the consumers in terms of better information, personalized products and service. Exploiting these data is also useful in order to improve the supply chain of the company. In many instances in China today, it is all about building a story with the consumer.

By Manon Bellon

Credits : Photography by 魏徐亮 Wei Xuliang

Chinese people are getting ready for the dog’s year, French President Macron offered a horse to his Chinese counterpart, yet another Chinese sign is drawing the attention of French exporters to China: the beef. During his official visit, Emmanuel Macron announced the total lift of the Chinese embargo on bovine meat “within six months”. The Beijinger wrote that this decision was welcomed by the F&B industry in China as well as all the meat lovers.

Origin (and end?) of the embargo

In 2001 while Europe was facing the crazy cow outbreak, China decided to shut its market to all European beef importers, then American, as a protection measure. In March 2017, the Chinese market slightly opened itself to French beefs: only deboned meats coming from beefs under 30 years old could be imported in China. Eventually, Emmanuel Macron announced a total lift of the embargo during his visit to China in early 2018, in a speech punctuated with some sentences in Cantonese, much appreciated from the Chinese audience.

An expanding market

This decision comes at the right moment. Many studies emphasize the current evolution in the habits of the 1.4 billion Chinese consumers, especially regarding the consumption of meat. As a result, the market is booming (it was multiplied by 10 between 2010 and 2015) while the French beef market is decreasing by 5% per year. Pork meat still makes the bulk of Chinese meat consumption, accounting for 60% of it. Yet, beef consumption is increasingly growing mainly because of the growth of the middle-class: in 2016, a Chinese would eat on average 4 kilos of beef when it was only 3 kilos in 2005, according to OECD figures. For comparison only, French consumption of beef is four times higher than the Chinese one.

The meat market is all the more attractive for exports that prices have been quadrupled in 15 years (3.5 euros per kilo today). Chinese growing middle class is now looking for quality. Thus, according to a note from the Dutch bank Rabobank, they tend to prefer to import meats despites the price.

Opening of the Chinese food sector to importations

If the Chinese food market used to be difficult to access, this situation changed since the 13^th Five-Year Plan (2016–2020). Indeed, the Chinese government officially opened China to the international food markets to ensure its food security. Today, China is a net importer of food with a deficit of 34 billion euros in 2015, according to Chinese custody. Every year 1.7 million tons of meat are imported to China, accounting for 20% of total food imports, as a result of the Chinese thirst for imported products in this domain. Food is also the third-largest sector for French exports to China, although meat only accounts for 9% of all exports. As China is about to become the largest importer of beef worldwide, before the United States, meat’s share in French exports to China is expected to increase in the future Franco-Chinese trade balance.

A high level of foreign and local competition

This decision is following the lift of the embargo on American beef last June. In Europe, France is the third country benefiting from it, after Ireland and the Netherlands. The lift regarding French beef was actually decided on March the 3^rd. 2017 but it was in a stalemate because of Chinese health requirements.

For the 150,000 French farmers raising beef (a sector worth 6.6 billion euros), the lift is a real opportunity, yet not a given one. Indeed, about 90% of the Chinese beef market is owned today by Australian, Brazilian and Uruguayan importers, and Chinese beef cattle is about 10% of the world cattle, five times more important than the French one.

Yet, unique French assets

French exporters are expecting about 50,000 tons of beef to be exported at first, which would amount to one fifth of all nowadays French beef exports. The market targeted in China is the high quality and high standing food market, but there is also an opportunity in the sale of unwanted meat pieces in France, such as beef tails, a piece mostly appreciated in China. In the 6 months needed for the lift to be effective, France has the opportunity to promote its French beef for its quality (sanitary traceability), for its specific cattle breed, or as a part of the French art de vivre.

Will poultry be next on the list? Discussions are still undergoing for a lift of the embargo that was imposed by China in 2015 following a bird flu outbreak.

To sum up

The beef market in China has been multiplied by 10 between 2010 and 2015, and still increasing. Both consumption and prices are on the rise in China, due to a growing middle-class. On this market, Chinese people particularly prize imported beef. Within 6 months from January 2018 on, it will be possible to export French beef in China.

By Manon Bellon