Study on the Future Opportunities and Challenges of EU ...trade.ec.europa.eu/doclib/docs/2007/february/tradoc_133310.pdf · Study on the Future Opportunities and Challenges of EU-China

Study on the Future Opportunities and

Challenges of EU-China Trade and Investment

Relations

Study 8: Distribution/ Retail

Study Experts: Stephen Michael Alexander van Kemenade Casper Jacobsen

A project implemented by:

“This report was commissioned and financed by the Commission of the European Communities. The views expressed herein are those of the Consultant, and do

not represent any official view of the Commission.”

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 1

EXECUTIVE SUMMARY China represents a great opportunity for international retailers, and due to a relatively liberal investment environment, offers a greater potential than many other service sectors. The dual attraction of a large and fast-growing domestic market, together with the extensive sourcing opportunities, makes China an indispensable part of any international retailer’s global strategy. Competitive Strengths and Market Opportunities

For European retailers, the future potential in the Chinese market is positive. Chinese retail and wholesale sales of consumer goods are expected to reach more than EUR 618 billion1 by the end of 2006. Of this figure, approximately 4% of sales (EUR 24.7 billion) are by foreign retailers. Assuming current growth trends continue, the total value of sales in the Chinese market could increase to around EUR 916 billion by 2010. European retailers should be able to capture a significant portion of these sales. China’s comparative advantage lies in leveraging its vast pool of surplus unskilled labour through labour-intensive manufacturing. Competitiveness in retail, however, is gained by focusing on lean operations, supply chain management, integrated procurement, effective quality controls and management flexibility as well as the ability to identify with local consumer preferences. Due to the weaknesses of Chinese competitors in these areas, predictions based on current market trends suggest that the foreign-owned market share could double by 2010. Recent surveys suggest that a new type of consumer is emerging in China, one that does not mind paying up to 20% more to ensure product quality, particularly when it comes to food safety. Foreign retailers are in a prime position to take advantage of the increasing disposable incomes of China’s inhabitants. European companies have been among the most pioneering in ensuring food safety, helping to build consumer trust and boost the competitiveness of food retailers as well as increasing productivity for distributors. Obstacles to Trade and Investment

While challenges to European and other foreign retailers largely remain operational in nature (e.g. recruitment and retention of talented staff, streamlining fragmented and old-fashioned distribution networks, etc.) there still remains some regulatory challenges which restrain foreign retail expansion. While many of these elements are not strictly speaking in conflict with China’s WTO commitments, they are often not implemented transparently and involving excessive red tape

for foreign retailers. These include limits on total store outlets a foreign majority owned company can open up, limits on store size, and limits on the sale of certain products. Even though local authorities can now authorise the opening of new stores, some provisions stipulate that central-level approval must still be sought after certain thresholds have been surpassed (e.g. number of stores in China). A number of other non-regulatory obstacles also exist, such as difficulties in obtaining land-use rights, and a lack of transparency, particularly in sub-sectors such as media. Counterfeiting is also a problem, particularly for brand-reliant products. Policy Recommendations

1. Lobby the Chinese government for equal regulatory treatment of foreign retailers including:

a. Removing the conditions on foreign majority ownership.

b. Removing the conditions for central-level approval.

c. Removing the remaining product restrictions

d. Clarifying or abolishing city planning requirements.

2. Improve and enhance the use of methodologies to assess impacts of proposed EU anti-dumping measures, which can often hurt European retailers (and consumers) sourcing goods from abroad. While there are currently instruments in place such as the Community Interest Test, there has been some criticism of its effectiveness.

3. Support Chinese customs reform to ensure uniform implementation of the WTO Customs Valuation Agreement, and reduce Customs formalities. This may be achieved through the Trade Facilitation negotiations. Some priority areas for the negotiations include reduction of excessive documentation requirements and greater coordination among local customs authorities to prevent inconsistencies in valuation procedures. Onerous testing and certification requirements (and in many cases inconsistent application) also makes the importation of goods a problem for retailers operating in China.

4. Establish inquiry points for market entry,

which can be especially helpful for SMEs as they navigate the complex administrative infrastructure.

Recommendations for Competitiveness

Since European retailers already find themselves in a competitive position vis-à-vis


domestic retailers, few radical changes in the current direction of European retailers are recommended. Nonetheless, a few important key principles are emphasised. 1. Build scale. Currently, no single retailer in

China is large enough to leverage cost-cutting logistics capabilities in procurement, inventory management and distribution.

2. Be involved in local/community policies. For an industry where each new store requires approval, good relations with both the central and local government are arguably the most important asset for

expansion in China.

3. Be flexible. China houses a kaleidoscope of different consumer preferences and regulatory environments.

4. Aggressively manage supply chains. As retailers cut production costs by sourcing from China, problems remain with rising costs from supply chain impediments.

5. Be actively involved in the development of trade policy in Europe and lobby on behalf of consumers.


TABLE OF CONTENTS Executive Summary ........................................................................................................................... 2 1. Introduction .................................................................................................................................. 7 2. Overall Sector ................................................................................................................................ 7

2.1 China in the global context................................................................................................7 2.2 Consumption Patterns .......................................................................................................8 2.3 Recent reforms...............................................................................................................10

3. Entry and Expansion of Foreign Retailers in China ............................................................ 12 3.1 Race for Market Share .....................................................................................................12 3.2 Forms of Foreign Investment: JV vs. WFOE ........................................................................14 3.3 Geographic Expansion .....................................................................................................14

4. Competitiveness Issues .................................................................................................... 17 4.1 Concentration.................................................................................................................17 4.2 Expansion Strategies: M&A vs. Organic Growth ..................................................................17 4.3 Productivity and Profitability.............................................................................................17 4.4 Challenges and Opportunities ...........................................................................................18

5. Remaining Market Access Obstacles ................................................................................. 21 5.1 Regulatory Restrictions ....................................................................................................22 5.2 Transparency-Related Issues ............................................................................................24

6. Outlook and Scenarios ...................................................................................................... 25 6.1 Scenario 1 - Baseline.......................................................................................................25 6.2 Scenario 2 - Optimistic scenario........................................................................................26 6.3 Economic Impact of Baseline vs. Optimistic Scenario...........................................................26

7. Recommendations............................................................................................................ 27 7.1 Policy Recommendations..................................................................................................27 7.2 Recommendations for Competitiveness..............................................................................28

Annex 1: Distribution/Retail Government Structure........................................................................ 30 Annex 2: Table of Key Laws and Regulations Pertaining to the Retail Sector................................... 31 Annex 3: Factors Influencing Competitiveness in the Chinese Market ............................................. 32 Annex 4: Industry Survey Results ................................................................................................... 33


LIST OF FIGURES Figure 1: China Retail & Wholesale Sales of Consumer Goods 1996-2010e....................................................8

Figure 2: Composition of Urban Household Expenditure 2005......................................................................9

Figure 3: Ownership Levels of Selected Household Goods ...........................................................................9

Figure 4: China’s Population Structure 2004..............................................................................................9

Figure 5: Sales by Store Format in 2004...................................................................................................9

Figure 6: Composition of Consumer Spending by Income Group ................................................................10 Figure 7: Composition of Retail Sales by Company of Origin in 2004 ..........................................................12 Figure 8: Sales of Foreign Retailers by Store Format ................................................................................13

Figure 9: Number of Selected Foreign Retail Outlets in China by Region by Mid-2005 ...................................14 Figure 10: Relationship between Provincial GDP per capita and Selected Retailers Hosted.............................15 Figure 11: Concentration Ration of Retail Industry in China.......................................................................17 Figure 12: Main Advantages of European Companies in the China Market ...................................................21 Figure 13: Strength of Chinese Competitors............................................................................................21 Figure 14: Market Access Obstacles for European Companies ....................................................................22

LIST OF TABLES Table 1: Presence of Top 250 Global Retailers............................................................................................8 Table 2: Top 25 retailers in China 2005...................................................................................................13 Table 3: Store numbers by region 2004..................................................................................................15 Table 4: Key 2005 Provincial Indicators, ranked by GDP per capita.............................................................16 Table 5: Performance Indicators by Company Origin in 2004* ...................................................................18 Table 6: SWOT Analysis of European and Domestic Retailers .....................................................................20 Table 7: Economic Impact of Market Access Obstacles – Industry Survey Results.........................................23 LIST OF BOXES Box 1: Challenges for European companies to conduct business in the Chinese distribution sector - Voices from

industry..............................................................................................................................................23


ABBREVIATIONS CCC China Compulsory Certification

CCFA China Chain store and Franchising Association

DIY Do It Yourself

DOFTEC Department of Foreign Trade and Economic Cooperation

EU European Union

EUCCC European Chamber of Commerce in China

FDI Foreign Direct Investment

FICE Foreign-invested Commercial Enterprise

FIE Foreign-invested Enterprise

FTL Foreign Trade Law

GATS General Agreement on Trade in Services

GDP Gross Domestic Product

GRDI Global Retail Development Index

HS Harmonized System

M&A Mergers and Acquisitions

MNC Multinational Corporation

MOFCOM Ministry of Commerce

RFID Radio Frequency Identification

SME Small and Medium-sized Enterprise

SWOT Strengths, Weaknesses, Opportunities, Threats

WFOE Wholly Foreign-Owned Enterprise

WTO World Trade Organization


1. INTRODUCTION For the global retail industry, little question of a China ‘threat’, i.e. one that entails a flood of low-price substitute goods from China, currently exists. Unlike in the manufacturing sector, China still has little competitive advantage in the service industries and is unlikely to develop such an advantage within the 5-year period covered in this study. While Chinese retailers still largely dominate their home markets, there have been very few successful attempts to break into overseas markets. On the other hand, European retailers, particularly the larger ones, have made successful inroads into the Chinese market. The Chinese distribution sector is often said to be one of the most open to foreign investment, particularly after a series of reforms in 2005. In fact, European retailers sometimes complain that it is not the Chinese competitors or government which pose a risk to their business, but protectionist measures stemming from home governments. This is illustrated by the supply chain disruption resulting from the 2005 textiles safeguards. Nonetheless there remain some cross-sectoral challenges which stem from the complexities of doing business in China. Though some discriminatory and restrictive regulations still exist, these are officially permitted under the conditions of China’s WTO accession. There is plenty of red tape and a lack of transparency, usually associated with some form of corruption. Currently, few mechanisms in international law exist to address such obstacles; hence a positive approach that seeks to highlight the benefits which European investors can bring, rather than a “stick” approach has been suggested by some of the companies interviewed for this study. This study will begin with an overview of China’s global role as both an investment destination and a sourcing opportunity for international retailers. It will then briefly touch upon consumption dynamics in China and the development of the Chinese retail industry. Foreign investment in retail and European investment in particular, will then be examined in more detail. This will be followed by a synopsis of regulatory developments and remaining obstacles. A broad scope of retail sub-sectors shall be covered in this study. Due to the rise of large-scale retailing and the diversification of inventories, product-delineated classification of retail sub-sectors makes little sense, and it is more appropriate to view the sector as

delineated by retail format. Hence, unless indicated otherwise, the retail sector will cover the entire spectrum of products sold to end-users, with the exception of catering. Due to data compilation methodologies in China, it will sometimes not be possible to separate catering from the rest, and to distinguish between wholesale and retail figures, though this shall be clearly indicated. This definition, while broad, is a useful one for the purposes of this study, as the bulk of European retail activities in China is done through the hyper/supermarket format (Chinese statistics do not distinguish between hypermarkets and supermarkets). These carry a highly diverse assortment of goods ranging from food to household appliances and fashion. Some focus will be given to the household appliances sector, however, this broad definition will be adopted for the greater part of the study. 2. OVERALL SECTOR 2.1 China in the global context Despite falling from 4th to 5th place on the 2005 Global Retail Development Index 2 (GRDI), China retains its position as one of the world’s most attractive retail markets with a massive consumer base, rising disposable incomes and a high rate of urbanisation. In 2005 retail sales3 reached RMB 5659bn, making China the 7th largest retail market4 in the world and the world’s largest emerging retail market. Hence there has been no shortage of international retailers entering the Chinese market in recent years, particularly since the 2005 reforms, which in effect threw open the doors of the domestic retail and distribution sector (see section 2.3 for details). This is seen in the increase of foreign investment projects approved by the Ministry of Commerce (MofCom). 1,027 foreign investment projects in retail and distribution have approved by the Ministry of Commerce since May 2005, compared to only 314 approved for the 12 preceding years5. As a result, competition between international retailers in China has intensified. This has resulted in a drop in the nation’s ranking on the GRDI index, which includes market saturation as an important factor. By January 2006, 31 of the world’s top 250 retailers 6 had already established operations in China, ranking it 11th (see Table 1) in terms of presence of MNC retailers. By comparison India, Asia’s second largest emerging market and No.1 on the GRDI, hosts only 5 of the top 250 retailers in the world.


Table 1: Presence of Top 250 Global Retailers

Rank Country No.

1 US 120 2 Japan 62 3 UK 61 4 France 45 5 Canada 44 6 Germany 43 7 Spain 41 8 Italy 36 9 Poland 32

10 Netherlands 32 11 China 31 12 Belgium 30 13 Portugal 29 14 Austria 26 15 Czech Rep. 24 16 Ireland 24 17 Switzerland 23 18 Taiwan 23 19 Denmark 22 20 Puerto Rico 21

Source: Deloitte, Emerging Market Group 2006

In addition to the domestic market, China provides a valuable opportunity to international retailers in the form of sourced goods. While exhaustive data on sourcing by retailers is not available, some indication of the scale can be given by looking at figures made available by individual retailers. Wal-mart, Carrefour and Metro together exported USD 23.8 bn worth of goods from China in 2004, which exceeded total domestic retail sales of FIEs in China for that year. The largest exporter is Wal-mart with USD 18 bn worth of

exports. This has led some commentators to remark that if Wal-mart were a country, it would be China’s 7th largest export market, ahead of Taiwan and Russia. These observations point to the fact that for international retailers, China’s role as a sourcing destination still takes prime importance when compared with its role as a market. Due to relatively late liberalisation of the distribution sector, foreign investment has been limited, and international retailers have as of yet barely scratched the surface of this vast market. This is due to change however, as foreign retailers increase their presence in the growing Chinese economy. 2.2 Consumption Patterns Retail sales of consumer goods have been following a path of steady growth for the last 10 years, averaging 10.1% growth a year, roughly in line with growth of per capita urban disposable incomes, which have grown at an average clip of 10.9% for the same period to reach RMB 10,493 in 2005. A trend line forecast suggests that by 2010, retails sales will reach RMB 9.2 trillion (Figure 1). In terms of the composition of consumption, food is by far the largest item of urban household expenditure in China, accounting for 36% (Figure 2). However, as incomes rise, this figure has gradually declined while relative spending on items such as transport and communication has been on the rise. This is particularly noticeable for automobiles, mobile phones and personal computers. Household ownership levels of these products has increased 6.8-, 7- and 4.3-fold respectively for the period 2000-2005.7

2.4 2.6 2.8 3 3.3 3.6 4.1 4.5 55.7 6.2

6.97.6

8.39.2

0

2

4

6

8

10

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

e20

07e

2008

e20

09e

2010

e

RM

B tr

ln

Source: China Statistical Yearbook 2006, Emerging Markets Group 2006

China Retail & Wholesale Sales of Consumer Goods 1996 – 2010e

Figure 1: China Retail & Wholesale Sales of Consumer Goods 1996-2010e


Food36%

Clothing10%

Householdappliances andservices 6%

Transport &Communication

13%

Health8%

Recreation,Cultural andEducation

14%

Housing10%

Other3%

Source: China Statistical Year Book 2006

Composition of Urban Household Expenditure 2005

Figure 2: Composition of Urban Household Expenditure 2005 One can expect this trend to continue in the long run as incomes continue to rise. As a rough comparison, food spending accounted for only 13% of household spending in the EU-25 in 2003. Urban ownership levels of household goods in China, while having risen considerably over the past 2 decades, are still relatively low. Figure 3 outlines the growth of ownership levels in selected household goods. If the big ticket spending items in the 80s and 90s were refrigerators and washing machines, then the current decade is marked by air conditioners, computers and mobile phones. Despite rapid growth, ownership levels still remain relatively low and there remains considerable room for growth (only 3.4% of urban households own a car and 41.5% own PCs compared to roughly 46% and 55% in the EU-258).

0

20

40

60

80

100

120

140

160

2000 2001 2002 2003 2005 2006e

Uni

ts p

er 1

00 h

ouse

hold

s

Mobile Phones

Microwaves

Air Conditioners

DVD Players

PCs

Source: China Statistical Yearbook 2006

Ownership Levels of Selected Household Goods

Figure 3: Ownership Levels of Selected Household Goods Population dynamics can also be expected to have a significant impact on consumption patterns in China. Interestingly, China and Europe share remarkably similar population

structures (though for very different reasons), with a constrictive pyramidal shape that peaks in the late 30s (Figure 4)9 As a consequence, retailers in China will have to adapt their inventories and retail formats to match an ageing population. The rapid rate of China’s urbanisation will provide retailers with higher-density clusters of customers in the long-run. The proportion of China’s population residing in urban areas has risen from 29% in 1995 to 43% in 2005, and the government has signalled its intention to continue encouraging migration from the under-employed countryside.

0 20000 40000 60000 80000

0 to 4

10 to 14

20 to 24

30 to 34

40 to 44

50 to 54

60 to 64

70 to 74

80 to 84

90 to 94

Age

Population

Male Female

Source: China Statistical Yearbook 2006

China's Population Structure 2004

Figure 4: China’s Population Structure 2004 The most popular store formats continue to be super/hypermarkets, specialty stores, and of course (though these are not documented), wet markets and neighbourhood grocers (see Figure 5).

Department Stores

Specialty Stores

ConvenienceStores

2%

Other1%

*Data for firms with sales exceeding RMB 5 mn

Hyper/Supermarkets

44%

Source: Statistical Yearbook of ChinaRetail Corporations 2005

Sales by Store Format in 2004*

40%

13%

Figure 5: Sales by Store Format in 2004


0%

20%

40%

60%

80%

100%

2000 2005

HighMid-HighMidMid-LowLow

Source: China Statistical Yearbook, Emerging Markets Group 2006

Composition of Consumer Spending by Income Group

Figure 6: Composition of Consumer Spending by Income Group However, recent surveys have shown Chinese consumers to be moving away from traditional to modern, large-scale formats for food safety and convenience reasons. It is also interesting to note at this point how store formats in China, particularly hypermarkets, differ from their European or American counterparts. This requires a look at Chinese consumer preferences. Compared to a Western consumer, the typical Chinese hypermarket shopper tends to spend less (between RMB 60-70) per trip, prefers fresh produce and consequently makes more frequent trips. They are also likely to be overtly interested in hyeine and tend not to won a car. Hence a typical hypermarket in China will be located in densely populated urban areas, with several store levels (due to space constraints). They will stock lots of fresh produce (rows of live fish tanks, for instance), have smaller pushcarts, a considerably higher number of checkout lanes and no parking lots. Chinese food products also tend to be packaged in multiple layers of wrapping. Another observable trend in consumer spending stems from the growing disparities of income distribution in China. While disposable incomes of ‘high’ income groups have doubled in the 2000-2005 period, those of ‘low’ income groups have seen much slower growth –about 30%- over the same period (see Figure 6). Hence, higher income groups are seeing a surge in consumer spending, contributing to an exploding market for big ticket items such as cars and luxury goods. Finally, the composition of GDP growth in China is worth mentioning briefly in the context of consumption patterns. Domestic consumption for the last few years was at around 40% of GDP growth, approximately 20 percentage points lower than the average developed economy. Growth has mainly been

driven thus far by investment and exports, despite government efforts to drive down the disproportionately high savings ratio by suppressing deposit rates. The main reason cited for this phenomenon is the inadequate social safety net, which leads consumers to save for a rainy day, as well as the underdeveloped consumer credit market. As China develops its consumer credit, pension and insurance systems and other aspects of social welfare, one can expect domestic consumption to increase at a faster pace than growth in population and disposable income. 2.3 Recent reforms Prior to China's WTO accession, foreign investment in the distribution sector was heavily restricted. In accordance with China’s services schedule and Article V paragraph 1 of China’s accession protocol, a gradual approach was taken to open the distribution sector and now, four years after accession, China’s distribution sector has been significantly liberalised in terms of provision of services and international trading rights. China’s GATS commitments cover the following sub- sectors: 1. Commission Agency services consist of the

sales on a fee or contract basis by an agent, broker or auctioneer or other wholesalers of goods/merchandise and related subordinated services.

2. Wholesale Trade services consist of the sale of goods/merchandise to retailers to industrial, commercial, institutional, or other professional business users, or to other wholesalers and related subordinated services.

3. Retail services consist of the sale of goods/merchandise for personal or household consumption either from a fixed location (e.g., store, kiosk, etc.) or away from a fixed location and related subordinated services.


4. Franchise services consist of the sale of the use of a product, trade name or particular business format system in exchange for fees or royalties. Product and trade name franchises involve the use of a trade name in exchange for fees or royalties and may include an obligation for exclusive sale of trade name products. Business format franchises involve the use of an entire business concept in exchange for fees and royalties, and may include the use of a trade name, business plan, and training materials and related subordinated services.

The main focus of this report is on retailing services. China’s service schedule prescribes that three years after WTO accession, all limitations on geographical location, number of establishments, equity ratio and form of establishment of foreign service suppliers as specified shall be fully lifted, with a few exceptions. The following sections highlight the main legal reforms which were implemented. 2.3.1. Foreign Trade Law Amendments

On 6 April 2004, amendments were made to the Foreign Trade Law (1994) granting international trading rights to Foreign Invested Commercial Enterprises (FICE), a newly-established type of legal entity. The amendments allowed for free import and export of goods and technologies and all enterprises (including a FICE established pursuant to the FICE Regulation) were granted full trading rights under these amendments. This provision, coupled with the subsequent grant of distribution rights discussed below, allowed foreign companies unprecedented access to the Chinese market. 2.3.2. The FICE Regulation

Whereas the FTL amendments concern trading rights, the Regulation on Management of Foreign Investment in the Commercial Sector (FICE Regulation) concerns the distribution rights of FIEs. Distribution rights are understood to include the right to engage in the internal sale, offering for sale, purchase, distribution or use of goods manufactured in or imported into China. In accordance with WTO commitments, all goods in respect of their internal distribution are subject to national treatment. Prior to the passage of the FICE Regulation, foreign companies were required to distribute goods within China through JVs with a Chinese partner. The FICE Regulation abolished this requirement, and introduced a new type of foreign-invested enterprise, the Foreign-Invested Commercial Enterprise (FICE) which is permitted to distribute products within China. In the past, this type of change

has been implemented gradually by the Chinese authorities, with new regulations introduced on a trial basis only, or with significant restrictions, such as high registered capital requirements and strict qualification requirements for investors. However, following December 11, 2004 the FICE Regulation introduced significant changes with relatively few restrictions. 2.3.3. Ownership and Entry Thresholds

The FICE Regulation generally allows Wholly Foreign-Owned Enterprises to distribute their full portfolio of goods throughout China. Certain quantitative entry barriers were also reduced. Entry threshold in terms of registered capital, average annual turnover and assets for foreign entities were lowered substantially for foreign invested enterprises. Effective from 11th December 2004, foreign retail enterprises were required to have a minimum of RMB 300,000 registered capital, and Wholesale enterprises were required to have a minimum of RMB 500,000. This is a marked departure from the previously prohibitive requirements. Requirements were removed on average annual sales and assets,10 and geographical restrictions on the opening of new stores were abolished, effectively opening the national market. 2.3.4. Application Process and Delegation of Approval Authority

The application process for obtaining FICE status involves two steps. The application must first be submitted to the provincial-level Department of Commerce and Foreign Economic Cooperation (DOFTEC) approval committee for preliminary review. Thereafter, the application is submitted to the central-level of MofCom for approval. The FICE regulation stipulates that the entire approval process should be completed within four months. Guidelines issued by MofCom in August 2005 helped clarify the procedure for establishing a FICE and European enterprises are now reporting that applications submitted are being dealt with within this four month period and have generally allowed for a smoother application process. As of March 2006, local DOFTECs are now in a position to approve new FICE establishments without central-level approval. This has been welcomed by the foreign industry as a positive step in the liberalisation of China’s distribution and retail sector, however, at present there are no experiences to verify the smooth operation of the new responsibilities of the local DOFTEC. In general, the application documents required in order to obtain FICE status are identical to the requirements for other foreign-invested enterprises (FIEs). However, the FICE


regulation introduces one notable addition to the requirements for retail FICE operations: foreign companies must now obtain a letter of approval from the local government(s) for the location of new outlets, indicating that proposed new retail stores should adequately conform to the urban and commercial development plans of the local government(s). Foreign industry has raised concerns on this issue, as it gives local officials excessive discretionary power in examining and approving applications for setting up new stores. This requirement also implies that urban commercial development differs on a regional basis. The foreign industry has raised concerns that this restriction is liable to irregular implementation across the Chinese provinces and that local officials could abuse such discretionary power as a market entry barrier to restrict the number of foreign distributor/ retailers while favouring Chinese competitors11. MOFCOM is currently amending its central guidelines for conducting urban commercial planning at the regional level, however, these are yet to be finalised.

3. ENTRY AND EXPANSION OF FOREIGN RETAILERS IN CHINA 3.1 Race for Market Share Liberalisation of the retail sector came at a relatively late stage in China’s reform process, with comprehensive lifting of investment restrictions on December 11, 2004 – at least in theory. Effective liberalisation came later in 2005 with the promulgation of new regulations in April and December. While most leading retailers had already established a presence in China prior to this period, the relatively late reforms have resulted in a heated race to open or acquire new stores. FDI in the wholesale and retail sector12 accounted for a mere 1.2% of total FDI in China in 2004. Although data for 2005 is not yet available, in view of the surge in approved foreign investment projects in the retail sector after the reforms, one would

expect a dramatic increase in FDI. At an initial glance, it seems that foreign retailers have gained a solid foothold in the China market, with non-Chinese firms holding about 11% (see Figure 7) of total retail sales in 2004. However, bearing in mind that data collected in China only accounts for companies with sales in excess of RMB 5 million, it is clear that if smaller retail outlets were taken into account the overall retail sales figures would be much higher. Estimates vary therefore on the sales share of foreign retailers in China, however, it is likely to be between 3-4%.

Domestic

83%

HK, Macau &Taiwan 6%

Foreign

11%

Data for firms with sales exceeding RMB 5 mnSource: Statistical Yearbook of China RetailCorporations 2005

Composition of Retail Sales by Company Origin in 2004

Figure 7: Composition of Retail Sales by Company of Origin in 2004 However, considering that the retail sector has only become de facto liberalised in 2005, foreign retailers have already notched up some initial successes and are still expanding aggressively. Of the 100 leading retailers by sales in China, 17 were foreign (excluding catering), contributing 20.6% of sales of the top 100 (see Table 2). Among these 17 were 6 Europe-based companies, whose combined activity accounted for 32.8% of sales by foreign retailers in the top 100, more than any other single non-domestic group.


Table 2: Top 25 retailers in China 2005 Current Ranking

2004 Ranking Company Name Sales (RMB

mn) Outlets (No.)

1 1 Shanghai Brilliance Group (Bailian) 72,074 6,345 2 2 Beijing Gome Electronic Appliances 49,840 426 3 4 Su Ning Electronic Appliances 39,718 363 4 15 CR Vanguard (Hua Run Wan Jia) 31,299 2,133 5 3 Dalian Dashang Group 30,117 130 6 6 Beijing Hualian 20,800 74 7 10 Wumart Group 19,072 659 8 9 Nonggongshang Supermarket Group 17,549 1,572 9 5 Carrefour 17,436 78 10 n/a Shanghai Da Run Fa 15,700** 60 11 7 Shanghai Yongle (China Paradise) 15,166 199 12 12 Chongqing General Trading Group 15,054 191 13 16 Jiangsu Five-star Electronic Appliances 14,612 193 14 11 Shangdong San Lian Group 13,201 274 15 13 Trust-Mart 13,200 96 16 17 A. Best 11,801 79 17 n/a Parkson Group 11,000** 36 18 22 Hefei Department Store 10,500 54 19 21 Lotus 10,060** 61 20 19 Jiangsu Wen Feng Great World 10,001 612 21 20 Wal-mart 9,934** 56 22 23 Home World 9,217 82 23 30 Li Qun Group 8,229 643 24 18 Wuhan Wu Shang Group 8,072 42 25 26 Wuhan Zhong Bai Group 7,994 385

Europe-based Retailers in top 100

27 n/a Hymall-Tesco 7,920 78 28 24 Metro 7,546 27 38 48 B&Q 5,160** 48 40 36 Auchan 5,000** 13 50 n/a Lufthansa Department Stores 3,559 8 *Data excludes catering **Estimates

Source: China Chain Store & Franchising Association

This may not come as a surprise as retailers of European origin typically tend to have a globally more diverse source of sales. While Wal-mart is by far the world’s largest retailer, only 19% of its sales came from non-US countries in 200213. Sears, Roebuck and Co. likewise made 90% of its sales within the US. Carrefour and Royal Ahold on the other hand, saw 49% and 80% of sales in none-home base countries respectively.14 More non-European foreign retailers, however, are entering the market. While the present position of Europe-based retailers remains dominant, it still constitutes a decline from the position held by Europe-based retailers in 2003, when they held over 50% of sales by foreign retailers in China. As for store formats, the data in Figure 8 shows clearly that the Hyper/Supermarket format is the preferred choice for foreign retailers in China, comprising

86% of sales of foreign retailers in 2004. Sales of foreign-invested Hyper/Supermarkets accounted for 21.5% of sales of all Hyper/Supermarkets in China for the same year.

Hyper/Supermarkets

86%

5%

ConvenienceStores

1%

Department Stores

7%

Hyper/Supermarkets

86%

Specialty Stores

5% ConvenienceStores1%

Single - BrandBoutiques

1%

Source: Statistical Yearbook of China Retail

Corporations 2005*Data for companies with sales exceeding RMB 5 mn

Sales of Foreign Retailers by Store Format 2004*

Figure 8: Sales of Foreign Retailers by Store Format


3.2 Forms of Foreign Investment: JV vs. WFOE

Due to regulatory restrictions, foreign investment vehicles in the pre-2005 period were mainly limited to Joint-Venture models. Despite the pitfalls of teaming up with a local counterpart, local knowledge has proved exceptionally useful in retail due to the strong regional nature of retail operations.

China is often described as a kaleidoscope of diverse markets with each region protecting its own industries, resulting in fragmentation of supply chains. Each region moreover has its own opaque set of tax and finance rules and different requirements for approvals. Local partners are often able to help in managing these regional complexities through their local networks, as well as in building indispensable good relations with local governments. Hence, there was no rush to buy out JV partners following the 2005 reforms as one might expect. This is in contrast with other sectors considering the degree to which foreign companies have been complaining about their partners in industries such as ICT and automotive. Foreign retailers have adopted a flexible attitude, buying out the more burdensome partners while keeping the useful ones.

In addition, since localisation is encouraged by the Chinese government, keeping domestic partners contributes to the projection of a strong local image, which has helped many retailers minimise red tape and curry favour with local governments. Some retailers even consider this an essential strategy, considering the plethora of approvals required to open new stores and restrictions placed on 100% foreign-owned companies. Nonetheless, WFOE’s are the preferred type of investment for most foreign retailers entering China post-2004. According to the Ministry of Commerce, roughly 61% of applications for market entry by foreign retailers in 2005 were under the WFOE format. 3.3 Geographic Expansion In terms of geographic expansion, foreign retailers have already established a solid presence in first-tier cities and have already began to move into second- and third-tier cities, the populations of which having soared due to urbanisation. Figure 9 shows, based on a selection of global retailers, the geographical distribution of foreign retailers in China. The wealthier coastal regions, with cities such as Shanghai, Beijing and Shenzhen, are not surprisingly host to the highest density of stores. We can also see that international retailers have entered most of China’s provinces, with Tibet, Ningxia, Hainan among the exceptions. Apart from the coastal provinces, Sichuan province with the mega-city Chongqing in central China is also heavily targeted.

No. of Selected* Foreign Retail Outlets in China by Region by Mid-2005

None1-5 stores6-10 stores11-20 storesMore than 20 stores

*Walmart, Carrefour, Metro, Auchan, B & Q, IKEA, Lotus, Ito Yokado, Tesco, Parkson, Leroy Merlin

Source: Ministry of Commerce 2005, Emerging Markets Group 2006 Figure 9: Number of Selected Foreign Retail Outlets in China by Region by Mid-2005 Shanghai, Beijing and Shenzhen are the wealthiest cities in China and consequently boast a modern retail sector. These are the first targets of foreign retail expansion in China. They are already home to a large number of supermarkets and hypermarkets, owing to high population densities and a boom in car ownership. While the hypermarket segments tend to be dominated by foreign retailers, domestic companies hold most of the market in the supermarket segment, with SOE giants like Lianhua and Hualian (Bailian Group) and Nonggongshang in the lead. Some cities, notably Shanghai are beginning to see a convenience store boom, filled by the rapidly-expanding number of suburban residential compounds. Usually ranging from 300-1000 square metres in size, these stores have filled a gap in the markets for formats which are larger and cleaner than the traditional Xiaomaibus 15 more conveniently located than larger 2000-3000 square meter supermarkets. Convenience stores initially followed a 7-11 model possessing in-house processing functions such as the ability to serve warm, cooked foods, but this model has seen limited returns on the much higher investment required outside of the major metropolises.

but

Many of the convenience stores chains such as Quik, Kedi and Alldays, are owned by the SOE giants like Bailian and Nonggongshang, though Japan’s Lawsons and Family Mart, as well as Taiwan’s C-Stores have already established in Shanghai. 7-11, having gained a foothold in southern China, is taking its first steps in Beijing. While European retailers have only made limited inroads, the convenient


retail format promises to become a stronger feature of the retail landscape in China, with store densities in cities such as Shanghai already reaching European levels. Despite some efforts from municipal governments to curb the expansion of convenience stores due to a desire to preserve the Xiaomaibus, retail sales by convenience stores in China increased by 65.5% to RMB 13.8 billion in 2004. 3.3.2 Increasing focus on 2nd and 3rd tier cities Following entry into first-tier cities, international retailers focused on the surrounding urban agglomerations, particularly the Pearl River delta (Guangzhou, Shenzhen), the Yangtze River delta (Shanghai, Hangzhou, Nanjing) and the Bohai rim (Beijing, Tianjin, Dalian, Shenyang), as indicated by the 3 darkest areas in Figure 9. Due to the lack of scale, nationwide distribution networks are not yet feasible; however, these three areas will form the basis for regional distribution networks, which will to some degree benefit from economies of scale. As foreign retailers build their national presence and reach a critical mass in the geographical distribution of stores, they will be able to take advantage of nationwide logistics platforms. Wal-mart executives, for instance, have already pointed out that China will be the only other country in the world where the retailing giant will be able to replicate its super-efficient logistics capabilities. With coastal markets approaching saturation, attention is shifting towards the inland. In 2004, inland regions saw the highest growth in new store openings; with the number of stores in western China growing over twice as fast as in the central or eastern regions. Moreover, growth in store numbers in 2nd tier cities (32.6%) outpaced those in 1st tier cities (15.7%). The move inland is being driven mainly by smaller specialty and convenience stores which have less space requirements and

hence are able to be more flexible in choosing location, typically around newly-built residential communities. Since inland regions are usually poorer, there is lower car ownership, and therefore consumers tend to do their shopping at a local, neighbourhood level, thus rendering large-scale formats, which tend to be fewer in number and require more travel to reach, less attractive. This is reflected in Table 3. As one moves west in China, the proportion of stores in a large retail format diminishes.

Table 3: Store numbers by region 2004

Overall Change YoY

Proportion of large stores **

East 38170 14.2% 34.4% Central 6696 15.1% 32.0% Western 10025 37.7% 14.3% *Data for stores with annual sales exceeding RMB 5 mn**Large format covers Department stores, Hypermarkets and Supermarkets Source: Statistical Yearbook of China Retail Corporations 2005

GDP per capita has been identified through correlation analysis as the most important factor in drawing foreign investment in retail, as suggested by the strong positive correlation in Figure 10. Other important factors include population and infrastructure development (as measured by road density), as well as the degree of urbanisation. Current household wealth however, has not been the sole consideration for international retailers. Despite the emphasis on coastal regions, investment has reached more remote and impoverished provinces such as Qinghai, Gansu and Xinjiang, with Carrefour already running two stores in Urumqi (which do not sell pork, owing to the large Muslim population in Xinjiang).

0

10

20

30

40

50

60

0 5 10 15 20 25 30 35 40 45 50 55

GDP per capita (RMB '000)

No.

of s

tore

s

Source: PRC Ministry of Commerce, Emerging Markets Group 2006

Relationship between Provincial GDP per capita and Selected Retailers Hosted

Figure 10: Relationship between Provincial GDP per capita and Selected Retailers Hosted


The two Xinjiang Carrefours illustrate Carrefour’s expansion strategy in China, which so far has worked well and made the France-based firm the leading foreign retailer in China in terms of sales. Xinjiang is one of China’s most impoverished regions, making it an unattractive destination for most international retailers. Only Carrefour and Malaysia-based Parkson have so far ventured into the western province. Short-term gains seem to be less of a concern in the case of the French chain. Securing prime locations in major cities nationwide is of much more priority, as shown by Carrefours’ expansion in 2000-2001, where it had ignored central-level

approval and dealt directly with local governments in opening new stores. The central government reacted by freezing Carrefour’s expansion for over a year, but by then the stores had already been opened and the best locations were secured. Carrefour has been commended for demonstrating the flexibility required to do business in China, while its competitors, such as Wal-mart, have been criticised for getting bogged down in negotiations at the expense of valuable expansion time. Table 4 provides an overview of Chinese provincial indicators ranked by GDP per capita.

Table 4: Key 2005 Provincial Indicators, ranked by GDP per capita

Rank Province / Municipality

GDP per capita 2005

(RMB)

GDP per capita CAGR

2001-2005

Total Retail Sales (RMB bn)

Population (mn)

% of population

living in urban areas

1 Shanghai 51486 10.3% 245 17.8 89.1%

2 Beijing 44774 11.6% 219 15.4 83.6%

3 Tianjin 35452 14.6% 105 10.4 75.1%

4 Zhejiang 27435 14.3% 365 49.0 56.0%

5 Jiangsu 24489 15.3% 416 74.8 50.1%

6 Guangdong 24327 9.9% 637 91.9 60.7%

7 Shandong 20023 16.3% 448 92.5 45.0%

8 Liaoning 18974 10.1% 264 42.2 58.7%

9 Fujian 18583 9.9% 200 35.4 47.3%

10 Inner Mongolia 16327 20.4% 89 23.9 47.2%

11 Hebei 14737 13.5% 252 68.5 37.7%

12 Heilongjiang 14428 10.8% 156 38.2 53.1%

13 Jilin 13329 12.0% 125 27.2 52.5%

14 Xinjiang 12956 10.9% 48 20.1 37.2%

15 Shanxi 12458 16.9% 88 33.6 42.1%

16 Hubei 11419 13.0% 267 57.1 43.2%

17 Henan 11287 16.0% 281 93.8 30.7%

18 Chongqing 10974 15.6% 96 28.0 45.2%

19 Hainan 10804 9.4% 22 8.3 45.2%

20 Hunan 10293 13.3% 207 63.3 0.0%

21 Ningxia 10169 12.0% 14 6.0 42.3%

22 Qinghai 10006 12.8% 12 5.4 39.3%

23 Shaanxi 9881 13.7% 97 37.2 37.2%

24 Jiangxi 9410 13.9% 106 43.1 37.0%

25 Tibet 9069 11.0% 6 2.8 26.7%

26 Sichuan 8993 13.9% 238 82.1 33.0%

27 Anhui 8783 12.3% 150 61.2 35.5%

28 Guangxi 8746 14.3% 97 46.6 33.6%

29 Yunnan 7804 9.8% 88 44.5 29.5%

30 Gansu 7456 12.2% 54 25.9 30.0%

31 Guizhou 5306 13.4% 58 37.3 26.9%

Source: China Statistical Yearbook 2006, Emerging Markets Group 2006


4. COMPETITIVENESS ISSUES

4.1 Concentration The retail industry can generally be characterised as a highly competitive industry with low levels of concentration, low-entry barriers and high-entry and exit rates. There are typically a large number of relatively small companies competing with naturally highly-differentiated products and with location being an important competitive factor (a convenience store located in a residential area has obvious advantages over one in an industrial complex). The exception is food retail, where, particularly in developed countries, concentration levels have seen notable increases in the recent decade, with the emergence of international retailing conglomerates such as Wal-mart, Carrefour and Metro. In the EU, for instance, the top 20 food retailers accounted for 40% of sales.16

Concentration Ratio of Retail Industry in China

0%2%4%6%8%

10%12%

1999

2000

2001

2002

2003

2004

2005

Mar

ket S

hare

Top 100 firms Top 10 firms

Source: China Chain Store & Franchise Association

Figure 11: Concentration Ration of Retail Industry in China China’s retail industry however, is highly fragmented, with the top 100 retailers accounting for 10.5% of total retail sales in 2005 (see Figure 11). While a wave of government-backed industry consolidation is taking place, competition remains fierce. Some retailers have pointed out that the distribution of profit margins across the supply chain are inverted: Where in Europe manufacturers see the lowest margins, followed by distributors, and retailers seeing the highest, in China it appears to be the other way around. While it will still take some time before concentration levels reach the same level as Europe, one can expect these levels to increase in coming years. The current degree of industry fragmentation makes comprehensive data very difficult to obtain. To simplify matters, statistics are only

compiled in China for retailers with sales in excess of RMB 5 million, thus excluding the omnipresent Xiaomaibu - small-scale, family-run convenience stores.17 4.2 Expansion Strategies: M&A vs. Organic Growth

Due to increasing levels of market saturation and fragmentation of the industry, expansion through mergers and acquisitions (M&A) has been an attractive option for retailers – both foreign and domestic - in China. Most retailers are choosing M&A as a fast-track growth option - Tesco became a player overnight by choosing to enter China through the acquisition of a 50% stake in Taiwan-based Ting Hsin Group’s Hymall. M&A also represents a way to eliminate competition. B&Q’s 2005 acquisition of 13 stores from Tengelmann’s OBI effectively left it with one real competitor – home improvement market leader Orient Home. It also helped B&Q jump 10 places up the Top 100 list to 38th place, boosting its sales an estimated 156% over 2004. Most importantly, however, has been the push to build scale, which allows retailers to drive down purchasing costs and create value through high-volume, low mark-up transactions. At the time of writing, the media has been reporting a silent bidding war currently underway between giants Carrefour, Wal-mart, Tesco and Lianhua for Taiwan-based Trust-Mart (15th place). Such a deal, regardless of which party wins, would be the most significant act of consolidation for China’s retail industry since the creation of Bailian (see next section), as offers from all 4 bidders are reported to have been in excess of USD 1 bn.18 Domestic companies are participating in government-backed efforts to build scale, none more so than state-owned mammoth Shanghai Brilliance (Bailian), which has been designated a ‘flagship enterprise’ in line with the 11th 5-year programme. Bailian was created in 2003 as the result of a merger between then market leader Lianhua, Shanghai Yi Bai, Hualian and Haomeijia. In 2005, Bailian took a 45% stake in Dalian Dashang (no.5), another SOE, forming part of a government-orchestrated effort not only to resist the emergence of foreign retailers, but also to create a national champion that will be able to expand into overseas markets. 4.3 Productivity and Profitability

Foreign companies, with relatively advanced business models, operational processes and management, have on the whole achieved greater profitability and productivity.


Table 5: Performance Indicators by Company Origin in 2004*

Store Format Company Origin Return on Sales

Return on Assets

Sales/ Employee (RMB '000)

Sales/ m² of floor space (RMB)

Domestic 1.46% 4.55% 520 15346

HK, Macau & Taiwan 0.06% 0.18% 529 13984 Overall

Foreign 1.74% 5.33% 610 23965 Domestic 0.81% 2.58% 426 13400

HK, Macau & Taiwan 0.23% 0.64% 579 14000 Hyper/ Supermarkets

Foreign 1.22% 4.64% 643 27500 Domestic 2.09% 7.06% 698 18800

HK, Macau & Taiwan 0.92% 1.33% 270 30200 Specialty Stores

Foreign 2.43% 3.16% 722 9500 *Data for companies with sales exceeding RMB 5 mn Source: Statistical Yearbook for China Retail Corporations 2005, Emerging Markets Group 2005

Margins, returns on assets, sales per employee, and even sales per unit of floor space are all significantly higher for foreign companies than for domestic competitors, as shown in Table 5. Due to cutthroat competition, margins19 are razor-thin. The national average, comprising foreign and domestic firms across all retail formats, is 1.41%, compared to 5.7% for non-food and 10.5% for food retail in the EU. While foreign retailers have the highest margins in China, the gap in profitability between foreign retailers and domestic ones, particularly SOEs, is not as high as in other sectors. A simple explanation for this fact is that many SOEs enjoy monopoly status in their sub-sectors due to restrictions on sales of certain products, for instance in tobacco. Furthermore, SOEs receive the best store locations from local authorities. Another explanation for the low margins may lie in the fact that the attention of foreign retailers’ management has been largely focused on expansion. Foreign retailers have been expanding their number of stores at around 20% a year. With so much of the management’s attention on opening or acquiring new stores, less focus is given to streamlining operations or on improving sales of existing stores. The productivity gap between foreign and domestic retailers is more significant. This is not surprising considering that state-owned retailers are obliged to retain staff in order to keep unemployment down. A visit to most state-owned department stores in China, with droves of idle blue-shirted employees sipping tea and chatting away behind the sales counters, will confirm this, though this is starting to change in recent years. Looking more closely at different store formats, one sees that the advantage of foreign companies is strongest in the

hyper/supermarket segment. As we saw in the previous section, hyper/supermarkets are the most important segment for foreign retailers in China, accounting for 84% of all sales by foreign retailers with sales exceeding RMB 5 million in 2004. The source of revenues for many retailers is also worthy of mention. Because of the market power exercised by many of the larger retailers they are able to negotiate extremely favourable conditions with suppliers. In many cases, suppliers must pay a fee to retailers for stocking their products. Large retailers are also often able to shift a significant proportion of market risk onto the suppliers by negotiating free return of unsold products. 4.4 Challenges and Opportunities

As is generally the case with foreign companies in China, the competitive edge of foreign retailers is maintained through their innovative product formats and streamlined management. For instance, the now popular hypermarket format was introduced by foreign retailers. Foreign retailers will no doubt continue to play a key role in bringing innovative technologies, such as RFID, to China in the future. 4.4.1. Fostering and keeping talent

Qualified supply chain managers are in great shortage in China. The China Chain store and Franchising Association (CCFA) forecasts that nationwide demand for personnel with university-level logistics training will reach 300,000, while there are only 5,000 logistics graduates annually. Considering that each new hypermarket requires around 400 new staff, including around 50 managerial staff, recruiting strategies take a high priority for retail executives in China. Competition among retailers is intense and salary levels for middle management are among the highest in the country. Foreign


retailers are generally able to offer competitive packages to most managers, and have been the most pioneering in training staff. Most of China’s qualified logistics professionals received their training while working for foreign companies. Carrefour and Wal-mart all have training centres in China, and use strong incentive schemes to retain their staff. Other retailers have tried selective hiring practices, such as targeting older workers, since workers younger than 30 tend to move on quickly. 4.4.2. Managing supply chains

Foreign retailers have yet to leverage one of the most crucial competitive instruments in retail – lean logistics and efficient supply chains. Foreign retailers currently have little choice but to rely on local distributors as they lack the type of scale required to be effectively served by a nationwide distribution platform. A survey of over 100 fast-moving consumer goods retailers commissioned by the CCFA revealed that overall satisfaction levels with suppliers was only at 51% in 2005. China’s local distribution networks are, as mentioned earlier in this study, highly fragmented and have very low levels of technological sophistication. Shipments pass through three, sometimes four distributors before reaching the client. An industry observer once remarked that a typical Chinese distribution company consists of a driver and a truck. In some provinces, trucks may even come as a luxury and the more common Sanlunche, tricycles outfitted to carry goods, are sometimes relied upon. This results in lost revenues and increased costs for retailers. Another CCFA survey of 13 fast-moving consumer goods including various toiletries and beverages placed the likelihood of a customer in any given hyper/supermarket finding at least one of the items to be out-of-stock at 9.9%. The situation however, is improving. The entry of foreign 3rd Party Logistics providers has heightened competition among distributors, and the growing scale of retailers has put pressure on distributors to consolidate in an effort to counteract growing buyer power.

4.4.3. Differentiating Products

The early phase of China’s retail modernisation was marked by intensive price competition in an effort to win over notoriously price-conscious Chinese consumers. A factor which made it easier for foreign players to be price-competitive in retail (a phenomenon almost unheard of in other sectors) stems from their ability to leverage global sales networks to purchase in bulk from China. This however, only works to a certain extent since many goods sold on the Chinese market have small differences between those sold on overseas markets. (For instance, Chinese mobile phones typically have small holes on the side so that the user can tie a string to it and hang it around his/her neck, or hang a keychain on it.) Price wars, however, eat into margins and retailers are exploring ways of differentiating their product. Focus fell on store environments and service, and some retailers began to radically experiment with different ideas. Recent surveys suggest that a new type of consumer is emerging in China, one that does not mind paying up to 20% more to be assured of product quality, particularly when it comes to food. A recent CCFA survey raised various problems associated with the distribution of food products including the use of unsafe storage materials, the absence of comprehensive cold chains, and generally the lack of compliance with hygiene standards during transport. The International Quality and Productivity Centre estimates that around 25-30% of fresh vegetables and fruit is lost during shipment. Retailers operating in other segments have differentiated themselves by offering after-sales services. For instance, B&Q have moved away from the DIY concept to home improvements by offering comprehensive interior design and installation services. This has been particularly effective in China due to increasing levels of home ownership in recent years, and the lack of Chinese enthusiasm for doing ‘it’ oneself. SWOT Analysis

Table 6 summarises the Strength, Weaknesses, Opportunities, and Threats (SWOT) of European and Chinese retailers discussed in this section.


Table 6: SWOT Analysis of European and Domestic Retailers

Europe China

Strength - Superior management, business models,

operational processes, after-sales service and capital

- Ability to leverage global networks - Innovative product formats

Strength - Established local brands, suppliers, trading

networks, clients and partners, government relationships

- SOEs have government backing (financial support, ability to obtain good store locations etc.)

- Rapidly modernizing, able to adopt international best practices through JV partners

Weakness - Less familiarity with local business

environment, consumer preferences

Weakness - No global networks - Less advanced operational processes/

business models - SOEs driven by non-commercial goals i.e.

employment - Poor understanding of foreign consumer

preferences

Opportunity - Sourcing of made-in-China goods for global

markets - Sourcing of foreign-made goods for Chinese

market e.g. wine - Large and growing Chinese consumer market

Opportunity - Large consumer base from which to base

overseas expansion - Proximity with and good knowledge of local

manufacturers/suppliers from which to base overseas expansion

- JV partners good source of management expertise

Threats - Government support for competitors - Poor supplier efficiency - Political backlash against foreign investment - Economic nationalism, negative publicity

Threats - Foreign retailers winning market share - Gradual abolition of government support - Foreign protectionism (for those Chinese firms

expanding overseas)


According to the industry survey conducted by the consortium implementing this study, European companies believe that product innovation constitutes the main advantage European companies have over Chinese companies (23.3% of times mentioned, Figure 12). Here, it is noted that products produced by European companies are generally more geared towards consumer needs then those made by their Chinese counterparts. Strong human resources of experienced and well-trained staff are also highlighted as being an important asset in maintaining a competitive advantage in the Chinese marketplace (20% of times mentioned). International brand name recognition, and the quality and service provision of European retailers is also highlighted by survey respondents as a strength (both received 16.7% times mentioned) Research and technological development accounted for a further 13.3% of response while 10% indicated ‘other’ 20 reasons.

20.0%

16.7%

16.7%

13.3%

10.0%

23.3%InnovativeProducts

HumanResources

Marketing &Branding

Quality &Service

R&D andTech. Dev.

Other

Source: Emerging Markets Groups. DEVELOPMENT Solutions (2006)

Main Advantages of European Companies

Times Mentioned

Figure 12: Main Advantages of European Companies in the China Market Despite these strengths, surveyed companies expect the strength of Chinese competition to steadily increase over the next five years. The capabilities of Chinese companies such as quality, design, technology and foreign know-how are improving, and thus present an increasing threat to European companies (33.3% of times mentioned, Figure 13). Government support and intervention (26.7%) in the industry is expected to further Chinese companies’ growth in the sector and with their lower cost base (20%), Chinese companies will become increasingly more competitive. Other

strengths (20%) identified include familiarity and knowledge of local market conditions and the ability to fully concentrate on their home market without the need to consider global operations as MNCs do.

33.3%

26.7%

20.0%

20.0%

Upgrading ofCapabilities of

Local Companies

GovernmentSupport &

Intervention

Lower CostBase

Other

Source: Emerging Markets Group;DEVELOPMENT Solutions (2006)

Strength of Chinese Competitors

Times Mentioned

Figure 13: Strength of Chinese Competitors 5. REMAINING MARKET ACCESS OBSTACLES21

Section Topic 5.1 Regulatory Restrictions 5.1.1 Conditions on Majority Ownership 5.1.2 Special Approvals 5.1.3 Rules Pertaining to Existing Manufacturing

Foreign Invested Enterprises 5.2 Transparency Related Issues 5.2.1 Customs Problems 5.2.2 Media Distribution 5.2.3 Real Estate Prices

Despite the 2005 reforms, some restrictions still remain, such as the limit on the total number of outlets a foreign majority owned company can open up, limits on store size, and limits on the sale of certain products. Even though local authorities can now authorise the opening of new stores, some provisions stipulate that central-level approval must still be sought after certain thresholds have been surpassed (e.g. number of stores in China). This suggests that the government is keeping a wary eye on foreign retailers becoming too dominant. A number of other non-regulatory obstacles also exist, such as difficulties in obtaining land-use rights, and a lack of transparency, particularly in sub-sectors such as media. Counterfeiting is also a problem, particularly for brand-reliant products such as fashion.


Although the Chinese distribution sector is positively regarded as offering significant opportunities for European retailers over the next 5 years, representatives from the European distribution industry have identified the following market access obstacles, (see Figure 14) which continue to inhibit growth and competitiveness.

25.0%

17.9%

10.7%

17.9%

7.1%

21.4%

Lack of Transparency in

Operating Practices

Complex Bureaucracy and

Government Intervention

Limited SupplyChannels

Lack of LegalFramework

IPRInfringements

Other

Market Access Obstacles for European Companies

Source: Emerging Markets Groups;DEVELOPMENT Solutions (2006)

Times Mentioned

Figure 14: Market Access Obstacles for European Companies Chinese operating practices such as a lack of transparency in operating practices (25%) was considered by surveyed companies to be significant obstacle to expansion in China. Complex bureaucracy and government intervention, especially at the provincial level also create barriers for European companies operating in the Chinese market (17.9%). In this regard, registration requirements for foreign invested companies are noted to be more stringent than for local competitors. The lack of an adequate legal framework and constantly changing product standards also hinders European companies (17.9%). Limited supply channels prevent European companies’ further access to the Chinese market (10.7%). Furthermore, the participating foreign representatives mentioned IPR infringements (7.1%), and other obstacles (21.4%) to expansion including lack of financial resources and the language barrier. Box 1 provides selected quotes from industry representatives in relation to challenges to be met in the Chinese distribution sector. Annex 3 provides a visual summary of both market driven competitive forces as well as those derived from NTBs.

The market access obstacles in China can have economic impacts on European companies operating in China. The respondents reported that as a foreign company they operate at a higher cost than Chinese companies due to the above mentioned barriers. One respondent estimated that operation costs are approximately 10-15% higher than those of local companies. Obstacles such as import tax, for which Chinese companies receive tax breaks, results in of revenue constraints of 4-5%. Overhead costs are estimated to be as high as 90%. See Table 7 on the following page for selected comment from the industry survey regarding the economic impact of market access obstacles.

5.1 Regulatory Restrictions

5.1.1 Conditions on Majority Ownership

The FICE regulation outlined in previous sections still poses some obstacles and is discriminatory in nature, imposing restrictions on foreign ownership, store size, number of stores, and merchandise sold. For instance, foreign ownership is limited to 49% ownership ceiling if the retailer should meet all of the following conditions: 1) The retailer has over 30 shops in China 2) The retailer sells any product listed as

restricted22 3) The retailer sells products with multiple

brands from multiple suppliers The first condition is straightforward. Authorities are keeping a close eye on any retailer becoming too large and eventually taking significant chunks of the domestic market from domestic companies. Carrefour, Wal-Mart, Metro and B&Q have already exceeded this threshold. The second condition is also fairly straightforward. The restricted products (see footnote 22) form part of China’s WTO accession protocol, which is the list of products subject to state trading. Powerful vested interests in China’s SOEs are naturally keen on seeing competition kept to a minimum in their respective sectors, and none more so than tobacco, regulated by the aptly-named China Tobacco Monopoly Administration. An unconditional ban exists for selling tobacco products, and foreign investment in the sector is close to non-existent. Liberalisation for some of these products, namely, automobiles and chemical fertilizers, is expected to come by the end of 2006, in line with WTO commitments. The third condition is perhaps the most obscure as to its purpose. Selling products from multiple suppliers is usually a practice which encourages competition; it is usually the practice of selling products from a single


Table 7: Economic Impact of Market Access Obstacles – Industry Survey Results Where respondent made estimates

Sub-sector Comment HP SM DP SS B CS O

“20% of turnover”- Wholesale to project developers and to retailers ●

“4-5% à When we import fixed equipment we need to pay an import tax but if we were a local invested company we would get a tax-break.” – Business to Business

●

“Our estimated operating costs are approx 10-15% higher than those for local businesses” ● ●

“We got only 1% sales turnover and market share in this market, as compared with our globally turnover.” – Oil, petrochemical, and power.

●

“In my business the current market situation results in an extra overhead cost of about 90% that has to be recuperated from our customers in comparison to other markets.”

● ● ● ● ● ●

Where respondents found it difficult to quantify market access obstacles: Sub-sector Comment HP SM DP SS B CS O

“This will be hard to predict since it involve not only current market but also potential new market.”

●

HP: Hypermarket SM: Supermarket DP: Department Store SS: Superstore B: Boutique store CS: Convenience stores O: Other

product which falls under the scrutiny of antitrust regulators, as this may be an indication that the retailer is engaging in exclusionary practices in order to share monopoly profits with the supplier. Therefore, it would seem strange that a practice which promotes competition would be scrutinised. A possible reason for this condition could stem from the impact of retailers on their suppliers. Dominant retailers are typically in possession

of enough buying power to negotiate favourable conditions with their suppliers, thereby forcing them to innovate and increase their competitiveness, or risk going out of business. It is likely that the suppliers of influential SOEs, who would rather keep their cosy relationships with the SOE retailers, are reluctant to allow retailers to gain such a position.

Box 1: Challenges for European companies to conduct business in the Chinese distribution sector - Voices from industry

The following are a selection of quotations from interviewees and the returned questionnaires: Q: What are the problems in doing business in China? “After application procedure and requirements have been clarified our company has applied for a distribution license, however, the application has been ongoing now for nearly a year and bureaucratic hurdles keep delaying the process.” “It is clear from the regulations that the central government does not want big retailers to expand too fast. There are a number of extra approval requirements for larger chains, and restrictions on foreign ownership.” “Our domestic rivals get big discounts on land and utilities and they get better store locations from the local governments.” “We’re losing at least 20% of turnover on counterfeits.” “When entering new local markets in China we find that local authorities will have preferences for using locally produced products.” “The land auction system should prevent corruption but really favors only real estate giants and slows down the process of getting a plot.”


5.1.2 Special Approvals

While, in principle, approval for new stores has been devolved to local-level authorities, there still remain a number of criteria and thresholds, which, when passed, impose the obligation to obtain central-level approval. If ANY of the following conditions are met, there is an obligation to obtain central-level approval: 1. The retailer engages in direct selling i.e.

engages in sales over TV, telephone, mail order, internet or vending machines;

2. The retailer deals in restricted products (covered in the previous section);

3. In the case of proposed new stores over 3,000 square meters, the foreign retailer already has over 3 stores in that size category in the province OR the foreign retailer already has over 30 stores in that size category in China;

4. In the case of proposed new stores over 300 square meters, the foreign retailer already has over 30 stores in that size category in the province OR the foreign retailer already has over 300 stores in that size category in China.

Direct selling was banned in China as a result of the proliferation of pyramid schemes in the 90s. Currently, it remains somewhat of a regulatory grey area; there has only been 1 licence awarded to a direct seller in China, though in theory the practice is permitted. The second, third and fourth conditions exist for similar reasons covered in the previous section. 5.1.3. Rules Pertaining to Existing Foreign Invested Manufacturing Enterprises

The FICE regulation allows non FICE FIEs, including those in manufacturing, to engage in wholesaling, agency commissioning, retailing and/or franchising provided they comply with the FICE regulation and amend the scope of their business accordingly. Hence, apart from establishing new Commercial Enterprises to engage in distribution, foreign investors and multinationals with existing FIEs in China are allowed to apply to expand their business scopes to include these additional activities. Before the issuing of the abovementioned guidelines by MOFCOM, local DOFTECs would not accept any applications for the expansion of business scope by existing FIEs, this issue now seems resolved one year behind China’s WTO schedule. The delay was not necessarily because of the desire to protect domestic companies, as has sometimes been the case with delays in WTO implementation in other sectors. Rather, it

appears to have resulted from the need for MOFCOM to coordinate with other ministries and departments, such as the General Administration of Customs and the State Administration of Taxation, to resolve various technical issues. For example, the distribution rights applications of bonded-zone companies were left in limbo in part because MOFCOM and Customs were still in the process of reaching an agreement on whether to treat goods that enter China from the bonded zones as imports or as domestically distributed products. New rules issued are basically in line with the principles of WTO Valuation Agreement. Manufacturing companies in China are eligible for distribution rights under the condition that revenues from distribution are kept below 30 percent of total revenue in order to continue to enjoy current preferential tax policies for manufacturing FIEs. Although uncertainties still exist with regard to how authorities will enforce this requirement.

5.2 Transparency-Related Issues

Despite positive developments in the regulatory framework covering the distribution sector, foreign companies still face a number of non-tariff barriers related to transparency and uniformity of implementation. Transparency-related issues are very much part of the daily business environment in China, and all the more so for the retail sector, where much of the business requires the involvement by local authorities. In wealthier provinces, local governments are perceived as being on par with the central government in terms of transparency, however in poorer provinces, issues ranging from incompetence to corruption constitute a obstacle for foreign companies. Typical transparency-related problems include vague regulations which leave a wide scope for administrative discretion, local protectionism, protracted approval procedures, government collusion with local businesses, administrative ‘power grabs’ (attempts to extract revenues or gain business secrets and technologies through new ‘regulations’), graft and bribery. The biggest victims of such problems are usually foreign SMEs. MNC investments are usually high-profile, dealt with by senior officials and welcomed because of the state-of-the-art technologies and prestige they bring to a province. Furthermore, MNCs usually have dedicated government relations personnel to handle administrative frictions. Retailers who stock imported products also typically face more problems than those who sell locally-produced products. This may not have so much to do with local protectionism as it has to do with getting the goods into the


country’s borders. There is a number of inconsistencies between central Customs policy and local practice at the different ports of entry. 5.2.1. Customs Problems

The European Chamber of Commerce in China (EUCCC) has reported a number of cases 23 where official guidelines to companies on import clearance procedures have not been followed in practice. Import classification rules are not interpreted at each port in a consistent manner according to the Harmonised System (HS), and in some cases, decisions are influenced by the duty rates. Steps are being taken by the General Administration of Customs (GAC) to establish an internal national tariff classification ruling database but it remains to be seen whether this will resolve issues of consistency in customs ruling. Valuation problems also persist, as post-WTO rules stipulate that the transaction value shall serve as the primary basis for determining the dutiable value of imported goods. However, European companies are reporting cases where Chinese customs officers continue to use minimum or reference price lists or in some cases even another company’s import values to challenge the import transaction values of imported goods. Customs officers are required to provide written explanations when they challenge the transaction value of imported goods. However, European companies have reported various cases where the Chinese customs are reluctant to provide such written explanations and if provided, written justifications lack detailed explanations or objective analysis and reasoning. 5.2.3 Real Estate Prices

One of the major complaints of nearly all the retailers interviewed for this study concerned artificially high real estate prices. As competition intensified over prime commercial real estate, so have prices, which soared to an extent where one interviewee’s price was as high as Western European levels. In addition, foreign retailers are reporting a non-transparent allocation system for land. A land auction system put in place to combat corruption has little effect, and large developers are still being favoured in awarding plots. 6. OUTLOOK AND SCENARIOS

Based on current trends the following outcomes are identifiable and could result in the following types of scenarios by 2010.

6.1 Scenario 1 - Baseline

Scenario 1 constitutes the baseline scenario and assumes that the current trends of

European retailers’ expansion in China continue, although not quite at the pace that has previously been the case. China’s economy continues to see strong GDP growth, while government policies toward retail and domestic consumption in general are not expected to change. No major changes to China’s current exchange rate policies are assumed and there are no major events which would alter the Chinese consumer’s perception or valuation of foreign goods. Assumptions:

GDP continues to grow at a similar rate experienced over the last five years.

No dramatic revaluation of the Yuan, the government relies on foreign demand to sustain economic growth through exports.

The government remains nominally supportive of foreign investment in the retail sector. However, conditions on majority ownership will constrain growth somewhat because thresholds limiting ownership to 49% are increasingly met. In addition, as attractive retail location sites become scarcer it becomes relatively more difficult for foreign retailers to obtain regulatory approval for building on certain cites (see Section 5 for further details).

Outcomes:

1. Total retail sales grow at an average rate of 10.1% until 2010, driven by strong growth in disposable incomes, urbanisation and population growth.

2. The market share of foreign retailers doubles to 8%. The industry structure supports a large number of less efficient smaller retailers, in second and third tier cities while larger national and foreign retailers continue to consolidate the concentrated and higher value markets in urban areas located mainly along the coast.

3. A low-value Yuan keeps exports and sourcing volumes high, while keeping Chinese consumer demand for imports low.

4. Domestic retailers, due to their relatively small-scale and a relatively weak Yuan are not able to substantially expand their presence abroad.

5. The overall share of European retailers in the Chinese market will increase. However their prominence among foreign retailers will somewhat diminish (from 32.8% today to around 27.5% in 2010).

Under this scenario, total sales in the Chinese retail sector would reach RMB 9.22 trillion by 2010. With a market share of 8%, foreign retailers would be responsible for around RMB


738 billion of these sales. For European retailers, the market potential (at a 27.5% market share among foreign retailers) could reach up to RMB 203 billion by 2010. 6.2 Scenario 2 - Optimistic scenario

Under this optimistic scenario a high economic growth rate is supported by a set of measures, in particular the continuation and strengthening of recent reforms, taken by the Chinese government to boost domestic consumption. Assumptions:

GDP growth is assumed to be the same as in the baseline scenario.

The government will promote higher domestic consumption in order to counterbalance potential risks that might arise from an over-reliance on export driven growth and foreign demand. Measures could include making consumer credit more widely available, a gradual appreciation of the Yuan and visible improvements in China’s social security system.

The role of foreign retailers supporting increased, more sophisticated, domestic consumption by offering innovative products and services not currently available in the Chinese market is recognised by the government. The government remains supportive of foreign investment in retail and allows industry consolidation trends to continue.

Outcomes:

1. Measures to increase consumption pay off with total retail sales growing at an average rate of 12% per annum until 2010.

2. Domestic investment as well as FDI in the retail sector accelerates to capture a share of the growing market. Recent examples of acquisition and expansion by foreign retailers into the Chinese market24, as well as consolidation among domestic players will intensify25.

3. A slow, but continuous, upward trend of the Yuan, combined with the increased attention paid by foreign retailers to the Chinese market, means that local sales begin to overtake sourcing volumes for overseas markets. An increased number of retailers will have to offer better quality products at competitive prices, while at the same time, the increased purchasing power of Chinese consumers (as a result of a combination of continued economic growth and a more valuable Yuan) means there are new opportunities for foreign retailers to offer their globally sourced

products to the Chinese consumer.

4. Foreign retailers expand their operations, with some acquiring smaller and weaker players, although most expansion occurs by opening up new retail outlets26 . The need for organic expansion would be particularly true in offering imported or higher value goods and services to a new urban middle class with increased purchasing power.27 The market share of foreign retailers could triple to 12%. Importantly, this increase in market share would not be at the expense of domestic retailers and would be the result of an increase in supply of new products and services appearing in the Chinese market.

5. Leading domestic retailers are able to expand abroad with greater ease due to international best practices adopted from cooperation with international retailers and a higher valued Yuan. Expansion will begin to South East Asian markets. In order to be able to expand abroad adequate economies of scale will be needed, creating further incentives for industry consolidation while at the same time further opportunities for cooperation (e.g. sourcing/ distribution agreement; legal partnerships, etc) between Chinese and foreign retailers will arise.

Under this scenario, total sales in the Chinese retail sector would reach over RMB 10 trillion by 2010. By offering new products and services valued by consumers, foreign retailers could account for 12% of the market (i.e. RMB 1.2 trillion of sales). For European retailers taken alone, an estimate of market potential may be made by assuming European retailers are able to sustain their current market share of 32.8% of foreign retail sales in China. This would result in EU retail sales totalling RMB 395 billion by 2010. 6.3 Economic Impact of Baseline vs.

Optimistic Scenario

Under the baseline scenario, the size of the Chinese retail market is expected to grow to RMB 9.22 trillion by 2010 where a slowdown in reforms are expected and consumer spending remains subdued. European companies are expected to capture a 2.2% overall market share valued at RMB 203 billion in sales. In the optimistic scenario, where China is able to make the radical transition from export- to consumer-led growth, European companies are expected to be able to gain a 3.9% market share of a larger RMB 10 trillion market (mainly due to an outward shift in the supply curve). European companies would see a sales value of RMB 395 billion by 2010.


If the Chinese government could therefore, implement further radicals reforms, European retailers would not only make RMB 192 billion more in sales, but arguably the overall welfare benefits (as measured by increased consumption) for Chinese consumers under such a policy could amount to up to RMB 780 billion28. 7. RECOMMENDATIONS

7.1 Policy Recommendations Thus far, EU-China trade and investment in retail has been largely beneficial for European-based retailers. Foreign investment in China’s retail sector is still encouraged by the Chinese government, and Europe-based retailers have done well in entering the Chinese market at a relatively early stage and building market share. Current obstacles mainly relate to “soft barriers” such as red tape which are largely manageable for large retailers but much more burdensome for SMEs. However, it remains to be seen how attitudes and policies will shift as foreign retailers build bigger market shares. Before considering possible actions on the policy level, it is important to note a distinction on the one hand between those issues that arise out of structural problems (i.e. those which may be resolved only through long-term growth and gradual improvement in the quality of political, judicial and economic institutions) and on the other hand those issues which can be solved relatively easier. Current regulatory barriers arguably fall mostly in the latter category as these are easier to target and to resolve. The restrictions on foreign majority ownership and requirements for central-level approval are an obvious example of this and could be neatly removed. Problems such as those relating to transparency are much more difficult to deal with, and require the long-term building up of strong institutions such as an independent judiciary and rule of law. Moreover, the central government has limited power over the practices of local officials and excessive foreign pressure in this area is sometimes counterproductive. Hence, it is recommended that the European Commission focuses its attention on regulatory obstacles. Structural difficulties are acknowledged by the Commission and approached positively, highlighting the benefits that European operators can bring to China, particularly in accessing foreign markets. Such an approach would address the concerns of a large number of European retailers that certain trade defence instruments, including anti-dumping and other

safeguards, can result in difficulties for European retailers sourcing from overseas. Hence recommendations are also made to mitigate such impacts. Recommendations: 1. Lobby the Chinese government for equal

regulatory treatment of foreign retailers including:

a. Removing the conditions on foreign

majority ownership; b. Removing the conditions for

central-level approval; c. Removing the remaining product

restrictions; d. Further clarification or abolition of the

city planning requirement.

Most of these constraints on foreign investment are not necessarily in conflict with China’s WTO commitments and foreign retailers have so far not reported any serious obstacles emanating from these rules. However, in the longer term, these issues lend themselves to administrative abuse and some, particularly the city planning requirement, are implemented with no transparency. City planning requirements, for example, are best dealt with by independent rules and regulations pertaining to the retail sector.

These regulatory constraints may be raised bilaterally or as a part of further dialogues under the WTO framework. It is also recommended that technical assistance is provided to MOFCOM and other government institutions responsible for city planning with the aim of finding better solutions to China’s urban development challenges.

2. Improve and enhance the use of

methodologies currently used to assess the impacts of proposed EU anti-dumping measures, which can often hurt European retailers (and consumers) sourcing goods from abroad.

While there are currently instruments in place such as the Community Interest Test, there has also been some criticism of its effectiveness29. Several measures can be taken to improve the test:

a. Conduct ‘active’ rather than ‘passive’

investigations. While current Commission practice provides interested groups with the opportunity to communicate their concerns, it does not proactively seek out and identify affected groups. While the interests of manufacturers are commonly represented in a concentrated form e.g. through associations, consumer


interests are more diffuse and may be more difficult to consider. It is therefore advisable that Community Interest assessments include quantitative analysis through the use of economic models.

b. Studies have found that community

industry size does not form a part of the community interest analysis. The scale of community industry should be incorporated into the assessment. Certain industries in the EU are relatively small and the costs associated with the imposition of measures are disproportionate incurring negative impact. For example, job-losses are often factored in as absolute are only short-term and in declining industries.

c. The theoretical basis of many

anti-dumping actions is based on unrealistic assumptions regarding competition, i.e. that firms in exporting countries are cooperating to lower prices, thereby putting community industry out of business so as to raise prices later, and that competition from third countries is non-existent. Consideration should be given to whether or not collusion among exporters really exists and the extent to which third country competition is a contributing factor.

3. Support Chinese Customs reform to

ensure uniform implementation of the WTO Customs Valuation Agreement, and reduce Customs formalities. This may be achieved through the Trade Facilitation negotiations. Priority areas for the negotiations including the reduction of excessive documentation requirements and greater coordination among local customs authorities to prevent inconsistencies in valuation procedures. Onerous testing and certification requirements and in many cases their inconsistent application also makes the importation of goods a problem for retailers operating in China.

4. Establish inquiry points for market entry,

which can be especially helpful for SMEs as they navigate the complex administrative infrastructure. Areas where inquiry points could be of assistance include advice on regulatory issues and approval procedures, liaison with administration officials, information on customs procedures, reliable local suppliers and distributors, and general advice on business conditions in China.

7.2 Recommendations for

Competitiveness Since European retailers already find themselves in a competitive position with respect to domestic retailers, few changes in the current direction are recommended. Nonetheless, a few important key principles are emphasised.

Recommendations: 1. Build scale. Currently, no single retailer in

China is large enough to leverage cost-cutting logistics capabilities in procurement, inventory management and distribution. Retailers should focus on opening new shops and acquiring existing retailers. Current fragmentation of the industry provides for many potential targets, and at a good price.

2. Be involved in local/community policies. For an industry where each new store requires approval, good relations with both the central and local government are arguably the most important asset for expansion in China. Retailers should focus on leveraging their abilities to deliver economic benefits to China’s regions through e.g. employment.

3. Be flexible. China is a kaleidoscope of different consumer preferences and regulatory environments. What works in one region will not necessarily work in the other. JV partners can be useful in this regard.

4. Aggressively manage supply chains. As retailers cut production costs by sourcing from China, the problem lies with costs arising from supply chain impediments. Distribution networks are highly fragmented and one should expect poor service from local distributors. Challenges may include counterfeiting, lack of tracking systems and poor levels of automation, lack of customer credit etc., all of which contribute to the remarkably high stockout rate of Chinese retailers.

5. Be involved in trade policy at home and speak out for the consumer. While manufacturers’ interest groups are extremely active in defending their interests, European governments need to hear more from consumer groups and retailers on trade issues. It is up to retailer and consumer associations to ensure that both positive and negative impacts are fairly represented to policymakers.


REFERENCES

Buyer power and its impact on competition in the food retail distribution sector of the European Union,

Dobson Consulting, Office for Official Publications of European Communities, Luxembourg 1999

China Chain Store Almanac, China Chain Store & Franchise Association, 2005

China Statistical Abstract, China Statistics Press,2006

China Statistical Yearbook, China Statistics Press, 2005

Distribution and retail in the PRC, Freshfields Bruckhaus Deringer 2005

Distribution services: Note by the UNCTAD Secretariat, United Nations Conference on Trade and

Development 2005

Europe in figures - Eurostat Yearbook 2005, Eurostat 2006

European Business in China: Annual Position Paper 2006/2007, European Chamber of Commerce in

China, 2006

Global Retail Development Index 2005, A.T. Kearney 2006

Global Powers in Retailing 2006, Deloitte 2006

Moving Forward on Distribution, US-China Business Council, 2005

Regulatory Reform in Retail Distribution, OECD Economic Studies No. 32, 2001

Retail: Food Sector, All China Retail Annual Report 2006, GAIN Report, USDA Foreign Agriculture

Service, 2006

Statistical Yearbook of China Retail Corporations in Chain, China Statistics Press, 2005

UNCTAD World Investment Report 2004, United Nations Conference on Trade and Development, 2005

White Paper 2006, American Chamber of Commerce in China 2006

Websites:

China Chain Store and Franchise Association

www.ccfa.org.cn


http://www.ccfa.org.cn/

ANNEX 1: DISTRIBUTION/RETAIL GOVERNMENT STRUCTURE

National Development &

Reform Commission (NDRC)

• Domestic market

analysis

• Drawing up

modern logistic

development

strategy

State Administration of Industry and Commerce

(SAIC)

• Approving, organizing

and supervising

retailers and their

activities

• Commodity quality

control in circulation

General Administration of Quality Supervision,

Inspection and Quarantine (AQSIQ)

• Quality control at

macro-level

• Formulating and

Implementing quality

control standards

Ministry of Commerce (MOFCOM)

• Establishing an open,

competitive and regulated

market mechanism

• Monitoring and regulating

market operation

Composing Ministries Directly Affiliated Organs Working Offices

Legislative Affairs Office

Department of Industry,

Communications and Commerce

Organisation Layer

Key regulatory

bodies

Relevance

• Participating in

making relative

laws and

regulations

State Council


ANNEX 2: TABLE OF KEY LAWS AND REGULATIONS PERTAINING TO THE RETAIL SECTOR

Key Laws and Regulations

Catalogue of （） Industries for Guiding Foreign Investment Revised 2004 ; Measures for the Administration on Foreign Investment in Commercial Fields promulgated on April 16, 2004. According to these two regulations, the commitments have been implemented. New relevant regulations include but not limited to: Law on Import and Export Commodity Inspection amended on 28 Apr 2002 Regulations for Compulsory Product Certification entry into effect Measures on the Administration of Wholesale, Retail and Lease of Audio and Video Products 2002-3-28; Decision of the Ministry of Culture on Revising the “Provisions of the Ministry of Culture on the Administration of Foreign-related Culture and Art Performances and Shows”, and Other Regulations 2004-7-1.


ANNEX 3: FACTORS INFLUENCING COMPETITIVENESS IN THE CHINESE MARKET

In addition to the genuine market driven competitive threats posed by Chinese operators in this sector, European companies also face competitive forces as a result of non-tariff or ‘behind the border’ barriers. Those NTBs which are deemed to result from strong Chinese government intervention are plotted on the right of the horizontal access while those derived from genuine competition

are plotted to the left. The author has indicated the relative importance of these competitive forces in terms of their position on the vertical axis with those nearer the top deemed as the most significant. The graph is designed as a guide only to give some perspective to the descriptions of competitive forces in this sector.

Impact on Competition

HIGHER

LOWER

Lower Cost Base Chinese Competitors

Factors Influencing Competitiveness of European DistributionCompanies Engaged in China-Related Business

Upgrading of CapabilitiesChinese Competitors

Customs Procedures

Unequal Access to Supply Channels

Lack of Legal Framework

Financing (Discriminatory Access)

IPR Infringement

Language Barrier

Ownership Restrictions (2)

Special Approvals (3)

Chinese Operating Practices (1)

Complex Bureaucracy Knowledge of Local Market Chinese Competitors

Nature of Competitiveness MARKET DISTORTINGMARKET DRIVEN

Notes: (1) Chinese operating practices here refer to a lack of transparency, corrupt practices and other forms of graft. (2) See Section 5.1.1 for further details. (3) See Section 5.1.2 for further details.


ANNEX 4: INDUSTRY SURVEY RESULTS

Distribution

SECTION 1: SECTOR OVERVIEW 1.1 Sample group profile

Table 1 – Sample Group Profile

MNC SME WFOE 6 WFOE 1 JV 1 JV Both 1 Total 8 Total % Sample 89% % Sample 11%

1.2 For how many years has your company been engaged in China-related business?

Chart 1 – Length of Engagement in China-related Business Activities

5 to 10 years, 22%

< 5 years, 22%

>10 years, 56%

Generally speaking the companies surveyed have substantial experience of operating in the Chinese market. All of the foreign companies participating in the survey have conducted business in the Chinese market for more than five years. 56% of the companies surveyed have at least 10 years of experience. 22% of the companies have 5 to 10 years of experience in China. 22% of those surveyed have had established offices in China for at least 5 years.


1.3 Which market segments does your China business operate in?

Table 2 – Market Segment Operating In

Market Sector No. of Responses % Hypermarkets 3 13.6% Supermarkets 2 9.1% Department Stores 4 18.2% Super Stores (e.g. DIY) 2 9.1% Boutique Stores 3 13.6% Convenient Stores 2 9.1% Others 6 27.3%

Table 3 – Surveyed Companies Scope of Business in China

Nature of Engagement

No. of Responses %

EU Exports to China: 7 33.3% China Production for export to Europe 4 19.0% China-based production for local market 5 23.8% Sourcing 4 19.0% Other 1 4.8%

The foreign companies surveyed were involved in various market segments in the distribution sector. This is demonstrated by the diversity in the market sectors in which the companies operate. In addition, 33.3% of the participating European companies export to China and 19% of the surveyed import China-based products. 23.8% of the respondents are involved in China-based production for the local market and 19% in sourcing.


SECTION 2: CHINA MARKET OPPORTUNITIES 2.1 - How important is the China market for your business in terms of sales?

Chart 2 – Chinese Market Importance

11%

0%

11% 11%

22%

0%

34%

22%22%

67%

0%

10%

20%

30%

40%

50%

60%

70%

Today In 5 years

% o

f res

pons

es

1 little importance 2 some importance 3 moderate importance4 significant importance 5 utmost importance

There is agreement among the respondents that the Chinese market will become increasingly more important to their business. Currently 56% of those surveyed considered the Chinese market to be of significant and utmost importance in regards to their sales. The respondents percieve that there will be a significant shift with 89% stating that the Chinese market will be of significant or utmost importance in 5 years time. 2.2 What is the percentage of your company’s turnover in China today compared to overall/

global turnover in sales and market share? MNCs, comprising the majority of the surveyed companies do not have a significant presence regarding sales and market share in the Chinese market. The MNCs reported only 1-8% of their sales are in the China market, with a number of companies reporting only 1%. In contrast, the surveyed joint venture company is entirely reliant on the Chinese market with 100% of their sales and market share from the Chinese market. 2.3 Over the next 5 years, how do you expect business opportunities to evolve in the retail

sector in China? How will this likely impact on your sales/ market share figures? There is an overall consensus projecting a positive future in the Chinese market with sales and market share figures expected to rise. Although slow, the respondents expect the Chinese market to expand, therefore increasing demand and predicting that sales will rise by 3-5% in the next five years.


2.4 How important is China as an investment destination?

Chart 3 – China as an Investment Destination

11% 11%11% 11%

33%

0%

11%

44%

34% 34%

0%

10%

20%

30%

40%

50%

Today In 5 years

% o

f res

pons

es


Generally, China’s importance as an investment destination is expected to increase in 5 years time. 45% of the respondents indicated that China as an investment destination today is of significant and utmost importance and 33% believe China to be of moderate importance. China’s importance is predicted to shift in 5 years time when on average China’s importance will shift from moderate importance to significant importance. Thus 78% of the surveyed believe that China will be of significant and utmost importance in five years time. 2.5 How much of a problem would you rate market access and other commercial practices

by China?

Chart 4 – Market Access and other Commercial Practice Problems in China30

13%13%

25%25% 25%

50%

25%

12% 13%

0%

10%

20%

30%

40%

50%

60%

70%

Today In 5 years

% o

f res

pons

es


A majority of the surveyed companies believe that market access and other commercial problems in China will decrease in five years time. 50% of the surveyed foreign representatives reported that problems with market access and other commercial practices in China are of moderate importance today, but will decline over the course of the next five years (25%).


2.6 What are the main current obstacles preventing you from expanding further in the

Chinese market? Please list in terms of priority (e.g. market access constraints, IP protection, Chinese standards/ operating practices, etc.).

Chart 5 – Main Current Market Obstacles

25.0%

17.9% 17.9%

10.7%

7.1%

21.4%

Lack ofTransparency in

OperatingPractices

ComplexBureaucracy and

GovernmentIntervention

Lack of LegalFramework

Limited SupplyChannels

IPRInfringements

Other

Number of times mentioned

Chinese operating practices such as a lack of transparency (25%) are considered by surveyed companies to represent a significant obstacle to expansion in the China market. Complex bureaucracy and government intervention, especially at the provincial level create barriers for European companies operating in the Chinese market (17.9%). In this regard, registration requirements for foreign invested companies are noted to be more stringent than for local competitors. The lack of an adequate legal framework and the constantly changing product standards by government agencies and ministries also hinders European companies (17.9%). Limited supply channels prevent European companies from further accessing the Chinese market (10.7%). Furthermore, the participating foreign representatives mentioned IPR infringements (7.1%), and other obstacles (21.4%) as barriers to expansion. These included lack of financial resources and the language barrier.


2.7 How will this situation likely evolve in the next 5 years?

Chart 6 – Market Access Situation in 5 years

Positive 54%

Negative 15%

No Change 31%

There is a general positive outlook with regard to the reduction of Chinese market access constraints (54%). Although the situation is expected to improve, it is perceived that it will do so at a slow pace especially in the area of policy and regulation.

Table 4 – Market Access Situation in 5 years

Selected Comments

Positive “We are optimistic that the government will improve the business environment for MNCs.”“In general we expect gradual improvement on both transparency of policies and regulations, and their enforcement.”

No Change “Will be improved but at a very slow pace” Negative “Chinese standards issues will likely get worse in many sectors but the legal framework

will hopefully improve.”


2.8 What are the quantitative costs or impacts resulting from these obstacles on your business today? This can be indicated as a percentage of revenues, profits, etc. Please specify.

Table 5 – Quantitative Costs or Impacts from Market Access Obstacles

Where respondent made estimates

Sub-sector Comment HP SM DP SS B CS O

“20% of turnover”- Wholesale to project developers and to retailers ●

“4-5% à When we import fixed equipment we need to pay an import tax but if we were a local invested company we would get a tax-break.” – Business to Business

●

“Our estimated operating costs are approx 10-15% higher than those for local businesses” ● ●

“We got only 1% sales turnover and market share in this market, as compared with our globally turnover.” – Oil, petrochemical, and power.

●

“In my business the current market situation results in an extra overhead cost of about 90% that has to be recuperated from our customers in comparison to other markets.”

● ● ● ● ● ●

Where respondents found it difficult to quantify market access obstacles: Sub-sector Comment HP SM DP SS B CS O

“This will be hard to predict since it involve not only current market but also potential new market.”

●

HP: Hypermarket SM: Supermarket DP: Department Store SS: Superstore B: Boutique store CS: Convenience stores O: Other

The respondents reported that as a foreign company they operate at a higher cost than Chinese companies due to the above mentioned barriers. One respondent estimated that operation costs are approximately 10-15% higher than those of local companies. Obstacles such as import tax, for which Chinese companies receive tax breaks, results in of revenue constraints of 4-5%. Overhead costs are estimated to be as high as 90%.


2.9 How is this situation likely to change in the next 5 years?

Chart 7 – Quantitative Costs and Impact Situation in 5 years

Positive 62.5%

Negative 25.0%

No change 12.5%

62.5% of the surveyed companies have a positive view of their situation in the next five years. It is believed that China’s expansion in the global market will increase the Chinese government’s efforts to decrease obstacles preventing expansion of European companies within China. A smaller proportion believe that in the next 5 years the situation will become negative or no change will occur at all because the Chinese government’s actions are unpredictable.

Table 6 – Quantitative Costs and Impact Situation in 5 years

Selected Comments

Positive “We expect these costs to decrease in line with Chinese government efforts to level the playing field. We expect and need a fair playing field in China.”

Negative “Central government will open wholesale market this year but no promise about import market. Even for the approval of retail/wholesale project, their rule and process are complicated and inefficient.”


2.10 How does the European distribution industry intend to maximise opportunities brought about by the Chinese market (e.g. outsourcing/ exporting to home markets, investment/ M&A, etc.)?

Chart 8 – Plans to Maximise Opportunities in the Chinese Market

33.3%

25.0%

16.7%

8.3%

16.7%

Merger &Acquisition

LocalProduction

StrategicAlliance withLocal Partner

Research &Development

Other


A majority of the foreign representatives stated that mergers and acquisitions can maximise their opportunities in the Chinese market (33.3%). Establishing more retail outlets in the Chinese market will increase their local presence, which is expected to increase profitable turnover. Furthermore, it the use of China has been recommended as their second home market to develop and launch new products in China. To reduce costs and optimise China’s strengths in manufacturing, the industry representatives suggested localised global production and development (25%). Joint ventures with Chinese companies are also highlighted to help increase market access (16.7%). 2.11 China’s 11th 5-year programme (2006 to 2011) sets ambitious targets and priorities for

rural development, environmental protection (rural and urban), energy efficiency (rural and urban context) as well as the need for a home grown innovation society, affecting all sectors. This direction would represent a major step change in China’s approach to sustainable development.

a. Please consider how the direction of China’s sustainable development as described

above provides opportunities and challenges within your own sector and business units (e.g. new markets, new investment opportunities, partnerships, etc.)?

b. What will likely be the challenges and constraints of realising these opportunities? The surveyed companies are optimistic about the opportunities China’s 11th 5-year programme will bring to the sector. A majority of the respondents have already invested in several sustainable development projects. The 5-year programme is expected to develop these invested industries sectors, thus increasing the market size. This will then create an increase in demand for European expertise, hence creating opportunities for European companies. Concerns were expressed regarding the Chinese government’s commitment to the 5-year programme and obstacles created by Chinese standard practices such as lack of transparency, bureaucracy and corruption. Local competition operating at lower costs due to lax implementation of environmental legislation was emphasised as being a continuing challenge to European companies.


Table 7 – Implications of China’s 11th 5-year Programme

a) Selected Comments

New market opportunities (1)

“We see tremendous opportunities along the way, in particular from healthcare, energy saving and better lifestyle perspectives.”

New market opportunities (2)

“Interesting development opportunities due to large demand.”

Higher standards (1)

“We have already made substantial investments in R&D for alternative energies in China (wind energy; solar etc). We hope that the next five year plan will further support the development of these industries and some up-front preferential treatment will be given by the government.”

Higher standards (2)

“We support the FYP and believe it will raise the bar for environment protection and foreign investment in manufacturing as well as retail for our sector. It is also a good opportunity for foreign investors to lead labour and environment protection for our sector.”

b) Selected Comments

Constraints (1) “Bureaucracy & transparency at local/provincial government levels; real commitment to execute plan at local level”

Constraints (2) “Preferential treatment might not be equally endowed on foreign MNCs as on local companies”

3.1 How significant is the competitive challenge of Chinese enterprises operating in your

sector in the Chinese market?

Chart 9 – Competitive Challenge of Chinese Enterprises Operating in the Chinese Market31

0% 0%

11%

0%

33%

22%

44% 44%

12%

33%

0%

10%

20%

30%

40%

50%

60%

Today In 5 years

% o

f res

pons

es


Generally, the foreign representatives perceive that the competitive challenge of Chinese enterprises today is of moderate and significant importance (77%) with 12% believing the challenge to be of utmost importance. There is then a shift to 33% in the five year persoective where the surveyed think the challenge of Chinese enterprises will be of utmost importance in 5 years.


3.2 Please describe the nature of the challenge. Include the role of SOE’s in your description. How is it evolving?

Chart 10 – Nature of Challenge of Chinese Enterprises Operating in the Chinese Market

33.3%

26.7%

20.0% 20.0%

Upgrading ofCapabilities of

Local Companies

GovernmentSupport &

Intervention

Lower Cost Base Other


A third of respondents, (33.3%) see the operating capabilities of Chinese companies improving,. This presents a major challenge to European companies. Government support and intervention (26.7%) in the industry sector will help close the technology gap between Chinese and European companies. And with their lower cost base (20%), Chinese companies will become increasingly more competitive. Other identified strengths (20%) include familiarity and knowledge of local market conditions and the ability to fully concentrate on their home market without the need to consider global operations as MNCs do.

Table 8 – Competitive Challenges from Chinese Companies

Selected Comments Upgrading of Capabilities Local Firms (1)

“Chinese products achieving higher quality, good design, high technology and overseas’ know how.”

Upgrading of Capabilities Local Firms (2)

“I have seen some new projects/ aspirations of Chinese competitors which will challenge our current niche higher value and premium markets.”

Lower Cost Base (1)

“Local companies can operate at lower costs than WFOEs. Once they catch up on quality and features, they will be very tough to beat.”

Lower Cost Base (2)

“SOEs are more familiar with Chinese operation practices, they can produce much cheaper product, and what’s more, they are able to grow more globally insights.”

Government support & Intervention (1)

“Local players in general have a lower ROI expectation, and in many cases have a lower cost of capital helped by local government financially.”


3.3 What are the main advantages your company has in China compared to Chinese competitors? Please list in terms of priority (e.g. Product/ innovation, brand, service/ maintenance, people, etc.).

Chart 11 – Main Advantages of European Companies


23.3%20.0%

16.7% 16.7%

13.3%

10.0%

InnovativeProducts

HumanResources

Marketing &Branding

Quality &Service

R&D andTech. Deve.

Other

The surveyed companies emphasised that product innovation is the main advantage they have over Chinese companies (23.3%). Here, it is noted that products produced by European companies are more geared towards the consumer’s needs then those made by their Chinese counter parts, therefore more marketable. Recruitment and retention of experienced and well-trained staff is also believed to be advantageous in maintaining a competitive edge (20%). 16.7% of the respondents noted international brand name recognition as an advantage while another 16.7% noted quality and services as important competitive qualities. In addition, R&D and technological development are also stressed as advantages European companies have in the Chinese market (13.3%). Other factors (10%) mentioned included government incentives and IPR infringements.


3.4 How significant is the competitive challenge of Chinese enterprises operating in your sector within the US market?

Chart 12 – Significance of Chinese Companies in the US Market

13%

37%

25%25% 25%25%

13%

37%

0%10%

20%30%40%

50%60%

70%80%

Today In 5 years

% o

f res

pons

es


With regards to the competitive challenge Chinese companies present in the US market, the respondents considered it to be of some importance to significant importance with none believing it to be of utmost importance. The situation is predicted to change over the next 5 years where 37% of the respondents believe that the challenge presented by Chinese companies will be of utmost importance. 3.5 Please describe the nature of this challenge. What is its likely future evolution (5yrs)? Even though there is recognition among the respondents that Chinese product quality will improve and will compete with European product standards in the international market, there is a consensus that Chinese products will not pose a great challenge in the US market in 5 years time. This conclusion is derived from the belief that the Chinese companies will not be able to meaningfully enter the US market because of the strength that local American companies will present in the industry sector. In addition, it is highlighted that it would be harder for China to effectively penetrate into a Western market because they lack local knowledge and resources.


3.6 How significant is the competitive challenge of Chinese enterprises operating in your sector in the ASEAN market and other Asian markets (e.g. India, Japan, etc.)?

Chart 13 – Competitiveness of Chinese Companies in

ASEAN and other Asian Markets

14%

72%

14%14%

72%

14%

0%10%

20%30%40%

50%60%

70%80%

Today In 5 years

% o

f res

pons

es


Overall, the respondents predict that China will be more competitive in 5 years time. The majority believe that the competitiveness of Chinese companies currently operating in ASEAN and other Asian markets to be of some importance (72%). A noticeable shift occurs when considering the challenge in 5 years time where 14% of the respondents believe Chinese companies to be of moderate importance today. This figure then increases to 72% when considering the situation in five years time. Where none of the respondents considered Chinese competition in ASEAN and other Asian markets to be of significant importance currently, 14% believe it to be of significant importance in five years time. 3.7 Please describe the nature of this challenge. What is its likely future evolution (5yrs)? There was a low response rate for this question. A few surveyed companies stated that China’s challenge in their industry sector in ASEAN and other Asian countries is very low and opportunities for further expansion are limited. It is also mentioned that Chinese companies focused on other industry areas with the intention of entering the markets of developed countries.


3.8 How significant is the competitive challenge of Chinese enterprises operating in your sector in the global market?

Chart 14 – Significance of Chinese Firms in Global Markets

14% 14%

58%

14%14%

44%

14% 14% 14%

0%

10%

20%

30%

40%

50%

60%

1 2

% o

f res

pons

es


A majority of the foreign representatives believe the significance of Chinese companies today to be of some importance (58%) with 28% reporting the challenge to be of moderate to significant importance. In 5 years time the surveyed believe that Chinese companies will become slightly more significant with 44% describing competition from Chinese companies to be of moderate importance and 28% regarding it to be of significant to utmost importance. 3.9 Please describe the nature of this challenge and its likely future evolution? There is a low response rate for this question. Of the selected responses, there is general belief that Chinese companies do not pose a significant challenge in the future. It was mentioned that Chinese companies are more focused in their domestic market and are now concentrating on export oriented business geared towards OEM (i.e. US and Europe).


3.10 To what extent does the infringement on IPR affect your business with China?

Chart115 – Effect of IPR Infringement on Business with China

25% 25%

0%

38%37%

12%13% 12%

25%

13%

0%

10%

20%

30%

40%

50%

60%

Today In 5 years

% o

f res

pons

es


The effects of IPR infringements are expected to decrease in five years time. 37% of the surveyed companies stated that the effects of IPR infringements today are of moderate importance and 38% believe it is of significant to utmost importance. In contrast, only 12% of the respondents believe the effects of IPR infringements to be of moderate importance and 25% believing them to be of significant and utmost importance in five years time. These figures suggest that the surveyed companies expect more stringent laws and regulation regarding IPR. 3.11 How will this situation likely evolve in the next 5 years? The infringement of IPR is expected to slowly decline along with improved government regulation and enforcement. In addition, it is noted that IPR will improve along with the living standards in China.


3.12 What are the overall efforts undertaken in your industry’s field of operation to maintain competitiveness vis-à-vis China?

Chart116 – Methods of Maintaining Competitiveness

22.7% 22.7%

18.2%

9.1% 9.1%

4.5%

13.6%

Localisation& Price

Reduction

ImproveMgmt &

Serv

ForeignDirect

Investment

StrategicAlliances

Quality &Innovation

R&D/Tech.Devel

Other


To maintain competitiveness within their industrial sector in China, price reduction through localisation (22.7%), improvement in management and services (22.7%) and increase in foreign direct investment (18..2%) were emphasised. Localisation such as hiring talented local employees will help keep costs lower than in European companies and the company will also gain local knowledge of the industry sector. Increase foreign direct investment is recommended in the industry sector to illustrate their commitment to the Chinese market, thus developing relations with the local industry and government. In order to increase market access, strategic alliances are recommended (8.7%). Investment in continuingl innovation in all key markets and R&D/Tech. development is vital to product competitiveness.


3.13 What is your priority in dealing with the challenge posed by the emergence of China/ Chinese industry as competitors? Please list and specify (e.g. improving your competitiveness, improving market access, seeking improvement in overall issues of commercial transparency).

Chart117 – Priorities to Maintain Competitiveness

27.8%

22.2% 22.2%

11.1%

16.7%

Develop LocalResources

ImproveCompetitiveness

Market Access Lobby forEnforced Policy &

Regulation

Other


Developing local resources such as outsourcing and developing local personnel to gain further knowledge and access to the Chinese market as well as ensuring quality service and management are keys to reducing some obstacles that are present in the Chinese market (27.8%). Improving competitiveness (22.2%) and expanding into new markets (22.2%) are also highlighted by the surveyed companies. Better enforcement of rules and regulations as well as increased transparency would help eliminate some standard operating obstacles and protect European investments (11.1%). Other methods mentioned to remain competitive are to study the Chinese market well so there would not be wasted opportunities, improve local business development competences and to develop good government relationships (16.7%). 3.14 Please highlight ideas for acceptable investment scenarios in China outside those

currently permitted by the Chinese government. Please be creative in considering EU-China win-win approaches to investment and cooperation.

Among the surveyed companies there is an emphasis on the development of a “fairer market” in China for European companies. In exchange, the surveyed companies suggest that the EU should create a fair market for Chinese companies in Europe e.g. for textiles and shoes. In addition, the development of an EU-China bonded warehouse zones is proposed where Chinese staff can be employed by the European companies. This is suggested to help set working standards and procedures in China.


Table 9 – EU-China Win-Win Investment Scenarios

Selected Comments

“If our up-stream suppliers were encouraged to invest in China this would help our competitiveness.” “EU program to help tier one Chinese companies to open up operations in the EU and establish stronger presence in Europe.” “Those big Chinese oil SOEs have had privileges/advantages in asset, network, etc. So if those assets and networks are made as a precondition for new market/industry entry, it represents effective discrimination against FOC which have just entered into China. So a fair play environment is important We urge a fair market in China. Meanwhile, EU should be fair to China in some European markets. e.g. textile/shoes. This bilateral benefit/respect and win-win solution can speed up the communication/collaboration process.” “EU-China bonded warehouse zones with low pricing and easy access for European companies”

“We would like to see more openness mainly in services areas, including: healthcare provisioning, financial services, content”


ENDNOTES

1 Please note that only retailers with sales greater than RMB 5 million are included in this figure. Figures which include China’s large number of individually owned small-scale shops (getihu) are not available and are believed to be significantly greater. 2 Published annually by AT Kearney 3 Figures include wholesale and retail 4 After US, Japan, UK, Germany, France and Italy, Retail Forward, 2005 estimates 5 Speech delivered by Assistant Minister of Commerce Huang Hai at 2006 China Retail Summit in Shanghai 6 By sales, Emerging Markets Group, based on Deloitte 2006 Global Powers in Retailing 7 China Statistical Yearbook 2006 8 Serves only as rough indication. Figure is for individuals, not households, and includes both rural and urban. Figures for 2002, Eurostat Yearbook 2005 9 As a consequence, China will soon be facing dependency problems as the bulk of the population enters retirement. This goes beyond the scope of the present report, however. 10 Previously, foreign enterprises had to have an annual turnover of at least US$ 2 billion in the 3 years prior to the application to establish a joint venture commercial enterprise; minimum registered capital of US$ 50 million and a minimum asset value of US$ 200 million. 11 Amcham China and Amcham Shanghai 12 China Statistical Yearbook 2005. Available data does not distinguish between wholesale and retail 13 UNCTAD World Investment Report 2004 14 The main reason for this is the fact that European markets tend to be smaller than US markets, forcing retailers to look abroad. Other considerations include the urban geography of European cities, which typically, due to their longer histories, have little space for large-scale outlets. 15 Xiao Mai Bu: small-scale, family-run convenience stores, which form an integral part of residential life in China 16 Dobson Consulting for the European Commission, 1999 17 Thus for certain sections of the report, data will refer to those retailers with sales exceeding RMB 5 mn. 18 The Standard, 20 March 2006 19 Calculated as the proportion of gross operating profit of turnover. Chinese statistics use the term “total profit”. 20 Other advantages include IP poitions and government incentives 21 Please note that a quantification of market access obstacles is not provided for this sector. The reason for this is two-fold. Firstly, it generally is much more difficult to quantify the cost of market access obstacles for services compared to traded commodities. This is mainly due to the absence of key data for these sectors (esp. trade data), which is required for any quantitative modelling. Secondly, with comprehensive lifting of investment restrictions on December 11, 2004 and implementation regulations in 2005, the Chinese retail market has recently become more open. An attempt of the quantification of market obstacles should the reform process stall is given under Section 6.3 of the

Scenarios section. 22 Books, newspapers, magazines, automobiles (until December 11, 2006), pharmaceuticals, pesticides, mulching film, chemical fertilizer, processed oil, grain, vegetable oils, edible sugar, or cotton, etc. 23 Annual Position Paper, European Chamber of Commerce in China 2006 24 At the time of writing, Wal-Mart, the US retail giant, is expected to announce a $1bn purchase of Trust-Mart, China's second-largest hypermarket chain. The acquisition of Trust-Mart will add around a 96 stores to its current 66, boosting its estimated $1.25bn sales in China by $1.7bn. If this deal gets regulatory approval then Wal-Mart will overtake Carrefour as China’s largest foreign retailer. Although Carrefour’s expansion plans are more gradualist this will give renewed urgency for it to fulfill its aims to open 20 stores in the country each year, in addition to the 78 it owns already. Other European retailers such as Tesco, who like Wal-Mart, have recently divested operations in parts of Europe, might also refocus on China expansion. 25 For example, China's biggest home appliance retailer, Gome Electrical Appliances, has recently clinched an industry-changing deal to acquire its rival China Paradise Electronics 26 This organic growth in market share is necessary due to foreign retailers opening up new market segments which, until recently, were unknown in many parts of China and which require the retailer to offer an altogether new retailing environment. 27 The presence of Ikea would be an example of this, where no previous Chinese competitors offering high quality and well-priced furniture exist and there is a gap in the market. As such Ikea has not taken away market share from domestic but has rather opened up an entirely new segment to the benefit to Chinese consumers and increasing not only the presence of foreign retailers in the Chinese market but also increasing the Chinese retail market as a whole. 28 This estimate narrows the welfare benefits to reform in the Chinese distribution sector and does not take into account the wider impacts of consumer-led growth on the Chinese economy. 29 See inter alia Treatment of the “Community Interest” in EU Anti-Dumping Investigations, Kommerskollegium, Swedish Board of Trade 30 These percentages have been rounded to two significant figures. 31 These percentages have been rounded to two significant figures.


Documents

Study on the Future Opportunities and Challenges of EU ...trade.ec.europa.eu/doclib/docs/2007/february/tradoc_133310.pdf · Study on the Future Opportunities and Challenges of EU-China