Understanding China’s Retail Market

China’s growing retail market offers a range of opportunities for foreign investors, but some sectors are easier to access than others.by Sheng LuChina has one of the most lucrative and rapidly growing retail markets in the world. Despite the global economic downturn, China’s retail sales hit ¥12.5 trillion ($1.8 trillion) in 2009, up 15.5 percent year on year. China’s booming retail sales are underpinned by the steady rise of household income. In 2009, the per capita disposable income in urban areas reached ¥17,175 ($2,515), nearly triple what it was a decade ago. In economically advanced cities such as Beijing and Shanghai, the average per capita disposable income is more than ¥26,000 ($3,810).

Better living standards have shifted people’s focus from satisfying basic needs to pursuing a higher quality of life, creating significant opportunities in the retail market. In 2008, China’s urban and rural households spent 37.9 percent and 43.7 percent of their incomes on food, respectively, down from 44.7 percent and 53.4 percent in 1998. Between 2001 and 2008, China’s household spending on clothing, healthcare, transportation, and telecom services more than doubled. These changes indicate that Chinese households have more cash available for discretionary spending than they did a decade ago.

China’s retail market structure

Because of the wide disparities among China’s regions and the country’s rural-urban income gap, purchasing power and retail demand vary greatly. According to the PRC National Bureau of Statistics, 42 percent of China’s total retail sales in 2008 came from (by rank) Guangdong, Shandong, Jiangsu, Zhejiang, and Henan—most of which are prosperous eastern provinces. In comparison, Tibet, Qinghai, Ningxia, Hainan, and Gansu had the lowest retail sales that year.

China’s retail market is highly fragmented and composed of many small and medium-sized retailers, unlike in the United States, where big-box retailers dominate. In 2008, China was home to about 549,000 retail enterprises, each with an average of 15 employees. Though the number of chain stores has been growing in recent years, cross-provincial retailers are still rare in China, in part because of local market access barriers.

Companies face different levels of competition depending on the retail sector in which they operate. China’s integrated retail business, which includes department stores and supermarkets, is dominated by slightly larger players. Businesses in this sector averaged 44 employees each and ¥17.8 million ($2.6 million) in earnings in 2008. Foreign-invested enterprises (FIEs) in China’s integrated retail market include giants such as Wal-Mart Stores, Inc. and Carrefour SA.

Motor vehicles, motorcycles, fuel, and auto parts are among the most lucrative retail businesses in China (see Table 1). These businesses contributed 39 percent of China’s total retail revenue in 2008, but accounted for only 14 percent of enterprises and employees. In comparison, sectors such as food and beverage, clothing and apparel, hardware and furniture, and pharmaceutical and medical device retail businesses face more intense competition and profit less.

Foreign investors still face restrictions

Only about 5 percent of China’s retail enterprises are foreign invested (see Table 2). According to the PRC Ministry of Commerce (MOFCOM), China had about 2,400 foreign-invested retail enterprises and $4.8 billion in total foreign retail investment by August 2009, 91 percent of which was invested after 2004. Despite the recent market entry, foreign retailers account for roughly 12 percent of the sector’s total sales and assets, suggesting that they operate on a larger scale than their Chinese competitors.

Before it joined the World Trade Organization (WTO) in 2001, China placed heavy restrictions on foreign investment in the retail sector. Under its WTO accession agreement, China committed to gradually eliminate market access barriers for foreign enterprises. Accordingly, the PRC government in 2004 issued the Administrative Measures for Foreign Investment in Commercial Sectors, which permitted foreign investors to establish retail enterprises in China without geographic limitations. (Previously, foreign retailers could operate only in major cities and special economic zones.) The measures also allowed foreign investors to provide retail services through joint ventures (JVs) or wholly foreign-owned enterprises (WFOEs). The 2009 Administrative Measures for Foreign Enterprises or Individuals Establishing Partnership Enterprises in China permitted foreign investors or individuals to establish partnership retail enterprises beginning in March 2010.

Despite removing geographic and ownership restrictions, China still places some limitations on foreign retailers.

Restricted products

Foreign enterprises that provide retail services for certain products—including agricultural chemicals, cotton, grain, oil, sugar, and tobacco—face market access barriers (see Table 3). For example, only JVs with majority Chinese ownership may sell different types and brands of these products from multiple suppliers through more than 30 outlets. Under such restrictions, foreign retailers must make concessions on the size and independence of their business to access China’s market.

Complicated licensing process

Foreign-invested retailers must typically go through stricter licensing procedures than their domestic competitors. Until recently, a foreign investor could apply for approval only from the central government to establish a retail business in China. The investor must first obtain a business license from MOFCOM and then registration approval from the State Administration for Industry and Commerce (SAIC). (Domestic retailers, on the other hand, can obtain licenses from SAIC directly, without receiving prior approval from MOFCOM.) The licensing process is also opaque and can be slow and inconsistent, adding extra costs and burdens for the investor. In recent years, pushed by foreign business communities and governments, MOFCOM and SAIC have delegated certain approval authorities to local governments and streamlined the licensing processes for foreign retail investors (see China Delegates Retail Approvals to Local Governments). Nonetheless, foreign retailers that have certain business formats or work with state-controlled items must still receive central-government approval, and the 2009 US Trade Representative report on China’s WTO compliance listed differentiated licensing processes as a continuing problem for foreign retailers in China.

Retail sector opportunities for foreign companies

Though retail as a whole is no longer considered an emerging sector in China, some of the sector’s sub-markets and business formats are just developing and receive strong support from the government, including funding, grants, and preferential policies. Foreign companies may find lucrative investment opportunities in these areas.

E-commerce

Between 2008 and 2009, the number of Chinese online shoppers grew 45.9 percent to 108 million, and online sales nearly doubled to ¥250 billion ($36.6 billion). About 90 percent of total online sales were consumer-to-consumer transactions, though the business-to-consumer model has also been successful in China’s e-commerce market. Apparel, audiovisual products, books, cosmetics, electronics, jewelry, and toys are among the most popular items sold online. Online shoppers are generally satisfied with the choice of products and convenient payment methods.

The PRC government strongly supports the development of e-commerce in the retail sector and aims to have online shopping sales account for more than 5 percent of China’s total retail sales by the end of the Twelfth Five-Year Plan (2011-15). The 2009 MOFCOM Opinions on Developing E-Commerce in the Distribution Sector lay out the types of retailers targeted for development:

• Online-only retailers that provide apparel, audiovisual products, books, home appliances, and home furnishings online;
• Multi-channel retailers that have traditional stores and offer online shopping services; and
• Third party e-commerce platforms that provide consumer-to-consumer or business-to-consumer services that help small and medium-sized enterprises and individuals conduct business online, such as Alibaba.com Ltd.

To improve the e-commerce market environment, the PRC government is turning to regulation. In addition to adopting the e-commerce model specifications and the Internet trading services specification (SB/T10519-2009)—two voluntary industrial standards that guide business models and transaction services—SAIC has also drafted Administrative Measures for Online Commodities Trading and Related Services, which were recently released for public comment. The measures specify the criteria and procedures for online business registration, emphasize protecting trademarks and company names, and task SAIC with monitoring online goods and services transactions.

Non-fuel services at fuel stations

China opened the refined oil retail market to foreign investors in December 2004 to comply with its WTO commitment. The 2006 Administrative Measures for the Refined Oil Market allowed FIEs to sell gasoline in China with few restrictions. By April 2007, MOFCOM had approved nine JVs and WFOEs to enter the refined oil retail market. These foreign enterprises—including oil giants BP Plc, Exxon Mobil Corp., Shell Oil Co., and Total SA—plan to build 2,517 fuel stations in China, 1,500 of which began operation in 2007. The latest MOFCOM statistics show that China had more than 111,300 refined oil retailers with about 976,000 fuel stations nationwide by the end of 2008.

China’s fuel station revenues still depend heavily on gasoline sales. Non-fuel value-added services such as shopping, food, and auto maintenance are just emerging in China but could increase in popularity as car ownership rises. Major domestic oil companies are already forming business strategies to take advantage of this growing market potential. For example, PetroChina Co., Ltd. saw its non-fuel business revenues grow nearly 70 percent to ¥1.96 billion ($287 million) in the first three quarters of 2009, and it plans to double the number of fuel stations that provide non-fuel services in 2010. Similarly, China Petroleum & Chemical Corp. (Sinopec) will open 3,477 new convenience stores in 2010 and aims to earn ¥3 billion ($439 million) from non-fuel business annually.

The PRC government also hopes to transform China’s fuel stations into comprehensive service stations and has promised incentives such as a favorable business licensing process for establishing new full-service stations. The Guiding Opinions on Promoting the Development of Fuel Stations’ Non-Fuel Services released by MOFCOM in February 2010:

• Encourage existing fuel stations to expand their business scope by offering shopping, food, leisure, and auto maintenance and repair services;
• Encourage new fuel stations to provide non-fuel services, especially fuel stations along national and express highways or near large parking garages; and
• May open business partnership and cooperation opportunities to logistics and convenience stores.

Drug retailing

China’s retail drug sales reached nearly ¥470 billion ($68.8 billion) in 2008 and have grown 15 percent annually since 1999. In 2008, China boasted more than 360,000 drug retailers, but only 491 of them had annual sales higher than ¥50 million ($7.3 million), indicating that the market is mostly made up of small enterprises.

The 2004 Administrative Measures for Foreign Investment in Commercial Sectors, which allow foreign investors access to China’s retail drug market, remove most restrictions but cap foreign investment at 49 percent in JVs if the FIE owns more than 30 stores in China. The Administrative Measures for Drug Business Licenses, issued by the PRC State Food and Drug Administration (SFDA) in 2004, detail the conditions for domestic and foreign investors to establish drug retail enterprises in China and task provincial and county SFDA branches with handling the licensing process.

Despite the expanded market access, foreign-invested drug retailers are still rare in China, in part because of the current healthcare system, under which 85 percent of drugs are sold directly through hospitals. As part of China’s healthcare reforms, the PRC government has announced that it will gradually separate drug sales from healthcare institutions, allowing greater market share and more freedom in drug price setting for retailers.

Meanwhile, China has strengthened administration of the retail drug sector. The central government recently named MOFCOM’s Department of Market Supervision as the leading government agency responsible for the administration of drug retail and distribution. The government also recently released several documents that lay out the future of the drug retailing sector, including the Opinions on Establishing the National Essential Drug System and the Notice on Strengthening the Administration of Drug Distribution in December 2009. These documents provide several market opportunities for foreign investors, including foreign participation in mergers and acquisitions and drug procurement. They also encourage chain stores that use modern logistics for urban and rural drug retail businesses. MOFCOM is working on several drug distribution services standards and has pledged to strengthen the distribution network in rural areas, which will create more favorable infrastructure conditions for chain stores.

Best practices

China presents one of the most attractive investment destinations for foreign retailers because of the country’s rising incomes and expanding market size. To succeed in China’s retail market, foreign companies should:

• Understand relevant PRC regulations and policies  China has complex business licensing processes and market access limitations. Foreign investors must be patient when expanding their China operations as regulatory challenges may cause delays. On the other hand, some policies have helped retail businesses by lowering market entry thresholds, encouraging certain business formats, and boosting domestic consumption. Foreign companies should watch PRC policy developments, align their strategies with government priorities where possible, and take full advantage of government programs (see Coming to Terms with Industrial Policy).
• Work with local business partners  This could be a wise entry strategy for foreign companies that are new to China. Local companies can contribute valuable resources such as business networks, government relations, and knowledge of local market conditions. Companies that have JV status may also have an advantage over WFOEs for some government incentive policies. Recent policies show that the PRC government sometimes prefers foreign investment in the form of mergers and acquisitions, which helps consolidate an industry and curb overheated competition.
• Offer third-party services  Retailers in China, like in any other market, need strong support from efficient business partners such as third-party logistics, distribution, wholesale services, and supply chain management solutions. Some of these services sectors are just beginning to develop in China, and the PRC government welcomes foreign investment that can provide the technologies and expertise to help them grow.

China is not a single unified market but a collection of local markets, each with different market demands, consumer behaviors, competition levels, and market access conditions. Establishing a successful retail business in China requires detailed market research and careful planning.

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China Delegates Retail Approvals to Local Governments

The PRC Ministry of Commerce (MOFCOM) and the State Administration for Industry and Commerce (SAIC) are the central government agencies tasked with approving business licenses and registration applications for foreign-invested commercial enterprises in China. In recent years, the agencies have gradually devolved this authority to local governments—a move that has simplified the licensing process for some foreign retailers.

MOFCOM and business licenses

Beginning in March 2006, MOFCOM delegated the authority to approve smaller foreign-invested commercial enterprises to provincial commerce branches. It also capped the license application review period at three months. In September 2008, provincial commerce branches began reviewing and approving applications for the establishment of all foreign-invested commercial enterprises, regardless of size. This change greatly helped foreign retail giants such as Wal-Mart Stores, Inc. expand in China.

Currently, provincial commerce branches and national economic and technology development zones can issue business licenses to all foreign retail investors except

• Enterprises that provide retail services through direct selling, mail order, the Internet, franchises, commissioned operations, or commercial management; or
• Retail businesses that involve items long controlled by the state, such as autos, cotton, fertilizer, grain, pesticides, pharmaceuticals, precious metals, publications, refined oil, steel, sugar, and tobacco.

Foreign retail enterprises that fall into these two categories must submit business license applications to MOFCOM.

SAIC and registration approval

Under the 2003 Administrative Measures on Authorizing the Registration of Foreign-Invested Enterprises, SAIC is responsible for the registration of all foreign-invested commercial enterprises in China, but qualified provincial or county governments may apply to SAIC for such authority. Currently, nearly all of SAIC’s provincial branches and about 100 county branches are authorized to approve foreign retailer registration applications.

—Sheng Lu[/box]

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China’s Strict Direct Selling Rules

China banned direct selling in the late 1990s, after several pyramid schemes using the model defrauded hundreds, if not thousands, of Chinese citizens. The country agreed to allow direct selling as part of its World Trade Organization entry agreement but still controls the industry tightly. The PRC State Council in August 2005 issued regulations on direct selling, which prohibited pyramid schemes and set rules for direct selling businesses. To facilitate the implementation of these two regulations, the Ministry of Commerce (MOFCOM) and State Administration for Industry and Commerce (SAIC) released several rules that cover the scope of products allowed for direct selling, the establishment of service networks, security deposit payments, and sales associates’ training. Because of concerns about fraudulent pyramid schemes, China maintains high market access barriers for direct-selling retailers.

Foreign investors that want to engage in direct selling in China must submit a business license application to MOFCOM and should hear back within 90 days. By the end of 2009, 24 enterprises had obtained direct-selling licenses from MOFCOM, including 13 foreign-invested enterprises. The licensing process remains opaque, leaving MOFCOM and SAIC a large degree of discretion over application decisions. At the 2009 US-China Joint Commission on Commerce and Trade, MOFCOM indicated that it was revising the direct-selling licensing procedure, which could improve the transparency of the licensing process. It is unclear when the new procedure would take effect.

—Sheng Lu

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[author]Sheng Lu is a research assistant in the Business Advisory Services Department at the US-China Business Council in Washington, DC. He is also a PhD candidate at the University of Missouri. Julia Zhao, assistant editor of the CBR, assisted with this article.[/author]