I've become rather fond of pairing articles that make sense discussed together as of late, so here's another brace for you. These two recent articles from the Financial Times cover the market entry progress of multinational retailers and financial service providers in the Middle Kingdom. The general impression is that retailers are doing rather less well than their banking counterparts in establishing a China foothold. Why? In a word, regulation.Whereas there are already several canny local retail groups in China that operate in a relatively open and competitive environment, banking is not yet as wide open--to the advantage of foreign banks which have obtained licenses to deal in yuan currency. That is, foreign banks benefit from stricter state regulation seen in things like healthier credit spreads mandated there. Let us begin with the competitive difficulties faced by foreign retailers. If they thought China was a vast, easy market to capture, they may have to think again and redouble their efforts. This op-ed on "retailers' fool's gold" is by Charles Kroeber of the China Economic Quarterly:
Next, here is Lex on how foreign banking operations are reaping more benefits--at least for now--from a less competitive financial services market where regulation is more rife:Global retailers thought they were going to strike it rich after the Chinese government lifted restrictions on foreign participation in the retail market in late 2004. Nearly three years on, the hoped-for bonanza seems mostly like fool’s gold. New foreign entrants face stiff competition from nimble domestic competitors. And even firms with an established presence will wait years before China significantly boosts their global bottom lines.
The Chinese retail market is quite a bit smaller than most people believe. Total retail sales in China are probably about $500bn. About half this figure represents subsistence purchases of food and clothing by people in rural areas and small towns and cities, which do not constitute a meaningful market for foreign retailers. Retail spending by urban consumers plausibly within reach of foreign retailers is probably around $250bn – about a tenth of US non-vehicle retail sales of around $2500bn. And even in this market, most consumers are still looking for the lowest price – not the higher quality or better service that foreign retailers can offer...
These big firms scent opportunity in the fact that the Chinese retail market is still relatively fragmented. The nation’s 30 biggest retailers accounted for 16.5 per cent of the national market in 2006, compared to figures of 37 per cent and 31 per cent in the US and South Korea respectively.
But fragmentation also reflects obstacles. The biggest is the high unit cost of distribution. Potential customers for foreign retailers are not evenly distributed around the country but concentrated in a few “islands”: two-thirds cluster around Beijing, Shanghai and Guangzhou – three cities as close together as Madrid, Belgrade and Moscow. Transportation is inefficient: logistics costs in China are 20 percent of GDP, compared to 8 percent in the US. So retailers are caught in a squeeze between high distribution costs and customers who always want the lowest possible price. In such a market, profits will be hard to come by...
More recent market entrants may find the going rougher, because they face entrenched competition. Best Buy launched its China operations in May 2006 with the purchase of Jiangsu Five Star, China’s third-biggest electronics retailer. Home electronics is the fastest growing organised retail sector in China, but unlike the hypermarket and home-furnishing sectors, it is already crowded with strong domestic competitors like the Gome Home Electronics, China’s largest retailer, and Suning Home Electronics. In recent years, these chains have been engaged in heavy spending on store expansion and vicious price wars, which have squeezed margins and soured relations with suppliers. Sun Weimin, president of Suning, says he plans to open 150 new stores a year until 2011. Best Buy ranks low on his list of concerns. “They’re a real lion, not a paper lion,” remarks Mr Sun. “But they’re still a small lion.”
They came, they saw and, while they have yet to conquer, foreign banks’ cash tills in China are ringing. In the first five months of 2007 overseas banks’ profits grew by an annualised 43 per cent, according to regulators; although the total is just $400m, shared among 75 banks...Western banks that have done so, including Citigroup, are rolling out more branches – the US bank opens its 20th on Thursday – in part to woo wealthy individuals. The latter often run their own companies and so bring corporate business too. Others banks concentrate on multinationals. Mitsubishi UFJ, Japan’s top lender, relies on Japanese companies for about 85-90 per cent of its China activity. But all foreign operators have an eye on a pool of 300m–400m potential individual customers, maybe 50m–100m of whom are in the middle-income bracket or higher.
The numbers are undoubtedly enticing, but high start-up costs aside, foreign banks are enjoying something of a sweet spot. Competition from the big local banks, only recently recapitalised, will prove formidable as they develop their products. The attractive interest rate spreads are a symptom of regulated rates – and thus have a limited shelf life. Foreign banks are also benefiting from a grace period allowing them to make loans beyond the stipulated 75 per cent of deposits. Unless they attract large local currency deposits, ambitions could be crimped when that waiver ends. The industry’s giants should emerge smiling, but expect several of their smaller rivals in China to fall by the wayside.
