Chinese Puzzle

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China is a country all about numbers...very, very big numbers. In February 2006, the Chinese government predicted retail spending in China would rise an average of 11 percent per annum until 2010, when it will have reached a staggering 10 trillion Yuan, or U.S. $1.2 trillion. And, it further announced, 2005 ran ahead of that prediction, posting an annual increase in retail spending of 12.9 percent at 6.7 trillion Yuan, or U.S. $800 billion.

All of this retail therapy is generated by a population currently estimated to be 1.3 billion. But, of course, by no means are all of these 1.3 billion people potential consumers of Western brands. Many, especially in the central and western provinces, still are living on around U.S. $1 per day.

"For us," says Ken Chaplin, vice president, Asia-Pacific and emerging markets, retail sales, and marketing, Disney Consumer Products, "by far the most important demographic is the 0 to 19 age group. That is our core market, and we estimate it contains approximately 370 million people." Chaplin goes on to make a comparison with the U.S., where he estimates that the 0 to 19 age group is roughly a quarter of the size with just 89 million people. However, he points out, "there is, of course, a marked disparity in spending power. The average disposable income for this group in the U.S. is $25,000 per annum, whereas in China it is just $729."

Much recently has been made of the retail potential of "China's burgeoning middle class," but, as with middle classes everywhere, it is not easy to get a precise idea of who these people are, and what their purchasing power actually is. Dr. Hui Tan, lecturer at the Leeds University Business School, defines the group as "those working in the private sector for foreign firms, and, to a certain extent, in government, higher education, and health," and estimates their disposable income as being "between U.S. $8,000 and U.S. $20,000."

Jordan Sollitto, executive vice president, international licensing and new business initiatives, Warner Bros. Consumer Products, however, believes "the Chinese middle class is not as affluent as many people claim, and, generally, have an annual income of between U.S. $6,000 and U.S. $10,000." But he does accept that "this is a sufficient level of income to give them discretionary spending power." Estimating the size of the middle class as "around 200 million," Sollitto expects "this demographic will grow by between 10 percent and 15 percent over the coming few years."

Disney's Chaplin estimates China's middle class annual income as "anywhere between U.S. $2,500 and U.S. $10,000. For us, it is currently a relatively small group, but there are signs that it will grow in importance. There is a definite move in this group to spend a higher percentage of their disposable income on goods other than groceries, especially toys, stationery, and branded apparel."

Debra Joester, president and CEO of The Joester Loria Group, believes "it is important to distinguish between 'the burgeoning middle class' and the genuinely affluent. There are restaurants in Beijing and Shanghai that charge New York prices, and, when you look around these places, you only see young faces. These are people known locally as 'astronauts,' and typically are the children of party officials who were sent abroad, made a lot of money in the U.S. or Europe, and now have come home to China to make a lot more." What you won't see, she continues, "are middle-aged and older faces that typically make up the middle class." While it is true that these people occasionally can treat themselves to a genuine Polo shirt in a department store for between U.S. $70 and U.S. $100, she adds, "they are not going to be able to afford the U.S. $500,000 a year it costs to belong to one of the top golf clubs."

Regardless of debates over income, China's middle class undeniably is massively concentrated along the eastern coast of China, and, in particular, the three largest cities of Beijing, Shanghai, and Guangzhou. Disney's Chaplin estimates "60 percent of all Chinese retail sales are located in the southern and eastern regions, and 20 percent in Beijing and Shanghai alone." This concentration of the retail market currently is helpful in that transportation in China is a major challenge. As Indra Suharjono, vice president, consumer products, Asia, Nickelodeon & Viacom Consumer Products, points out, "There is very little infrastructure in the country as a whole, and transportation is a major problem. This concentration makes these three cities very expensive, with a consequent drain on ROI. Thus, even though this is where the bulk of the consumers are, many people will plan to launch their stores in these major cities—Shanghai, in particular—and then franchise them to the rest of the country where costs are much lower, and consequently ROI is much higher."

This is possible, because, as Joester, explains, "Chinese retail runs on a concessionary model, not too dissimilar from Japanese retail. Under this model, a manufacturer will pay to take space in the major stores and takes all the risk associated with selling the goods, which makes it absolutely essential for a licensor to work in China with a local partner that is both financially sound and experienced in managing concession and freestanding retail operations."

Some, such as Rita Rubin, senior vice president, international licensing, United Media, see positives in the system. "One of the advantages," she insists, "is that it allows you to get much better control of the cash flow."

And there can be other advantages, too, if, as emphasized by Joester, you pick your partner carefully. Warner Bros. Consumer Products recently formed a joint venture, PMW with Hutchinson subsidiary Hong Kong Harbour Ring, which owns a significant amount of retail space in China, and consequently, says WBCP's Sollitto, the company pays no rent on any of its boutiques, or on the flagship Warner Bros. store, which opened earlier this year in Shanghai.

Even with such a powerful local partner, and such an inherently strong lineup of properties, Sollitto sees China as a market in which it is absolutely necessary to take the long view. "Anyone," he insists, "who approaches China thinking that within 18 months they'll be in big money is just kidding themselves. If you want to go into China, you have to see it as a five- to 10-year project." Why? "At a fundamental level, you look at China and realize it is vital to have a strong local partner, but when you start looking for that partner, you quickly realize there really isn't one that understands the business of licensing. So your best bet is to find a strong, financially sound partner who is capable of learning. The next major problem," he continues, "is price pointing. We look at China as a market in which we recognize that we won't make as much profit per item sold as in the U.S. and Europe, but we hope, over time, to generate significant volume. But it certainly won't be easy."

One reason cracking the Chinese market isn't an easy proposition is the difficulty of generating the oxygen of licensing: exposure. "One very important way that China differs from many other markets," opines Disney's Chaplin, "is that, unlike most of the rest of the world, we cannot rely much on promotion from our sister operations. The nature of government censorship is such that we cannot rely on television and feature films for promotion, and the Chinese DVD market remains challenging." Disney seeks to overcome these constraints with "a combination of quality retail space, special events such as Disney on Ice, small theatrical tours, its Hong Kong theme park, and retail promotions such as the one that kicked off in May involving customers collecting laser holograms that fit into a collecting card," Chaplin says. "When they have the full set, they can enter a competition in which the first prize is a holiday in Hong Kong."

Events are an important element in the promotion of Snoopy for United Media, too, and Liz Brinkley, the company's director, international licensing, reports that in addition to making 2006 "the Year of the Beagle" to coincide with the Chinese Year of the Dog, the company also organized, "a major presence at the huge annual ice carving festival in Harbin," a city in China's northeast. "Not only was every Snoopy character represented, but there was an ice carving of Snoopy's house large enough for people to walk through. And," she adds, "we recently opened a Snoopy Café in Beijing."

Clearly, China offers a potentially enormous opportunity, as well as some equally large challenges for those who wish to realize that potential. "China," says Joester, "is a complex and difficult market, one that will not be easily cracked, and which will take time and money on the part of those who will succeed."

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