EY Greater China Consumer Products and Retail Sector ... · PDF fileWith the Winter issue of...
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2 EY Greater China Consumer Products and Retail Sector Journal |
Eric Chia
Partner Greater China Consumer Products Sector Co-Leader
Arnold Sun
Partner
Greater China Consumer Products Sector Co-Leader
2 EY Greater China Consumer Products and Retail Sector Journal |
Dear Friends,
With the Winter issue of Greater China Consumer Products and Retail (CPR) Journal coming out, we are
celebrating our first anniversary of the Journal.
I recall that, in our opening note for the first issue, we were expecting a lot of the uncertainties during the year –
intriguing to see how quickly and phenomenally that changes are taking places in the world. On one hand,
mainland China has started to see the “New Normal” in place – with a GDP growth rate under 7% for the first time
in the past 2 decades – and lots of pressure on the traditional brick-and-mortars to re-think their business and
operating models; on the other hand, a shift in focus to “consumerism” has, in part at least, resulted in a set of
themes in the CPR sector, including the booming of O2O, growing in number and value of inbound and outbound
investments.
In this issue, we are glad to share with you three of our perspectives that address some of the key developments
in the China CPR sector:
► “Tapping into China’s New Consumers: Getting Sales Channels and Logistics Strategies Right to Drive
Profitable Growth” (By Alan Beebe, Director; Penny J Cao, Senior; Grant Lin Senior, Advisory services of EY
Advisory) – New opportunities emerge with evolving economy development patterns and consumer behaviors.
So do challenges. Lin has rightly pointed out five distinctive trends in the sales and logistics arenas for
consumer products companies and proposed compatible strategies that ultimately drive profitable growth for
the consumer products companies in the mainland China market.
► “New Integration Era for Consumer Produce and Retail Sector in China” (By Hsuan Chen, Executive Director,
TAS Services of EY Huaming LLP )
► – While the inbound investment in the CPR sector continues its way of growth, multi-national corporates are
certainly facing new threats during the integration phase in the China context, including stronger local
competitors, difficulties in “going down” to lower tier markets, etc. Chen has called for a new strategy in
integration: a “Best of Breed” approach that will assist the acquirers to retain the most appropriate of the
transactions.
► “Digital Luxury strategy capturing the Chinese mass market” (By Lilly L Cheung, Senior Manager, Tax
Services of EY Huaming LLP ) – Inspired by the success of newly coined festivals 11-11, and 12-12, the
Operating Model Effectiveness team at EY has completed a deep dive study into the digital market strategy,
operating model and operational transformation needs in the retail sector. In this report, the team has
articulated a broad spectrum of findings in both strategies and operations, with a clear layout of different
options for market leader to consider.
3 EY Greater China Consumer Products and Retail Sector Journal |
Tapping into China’s New Consumers: Getting Sales Channels and Logistics Strategies Right to Drive Profitable Growth Alan Beebe
Director, Advisory Services
Penny J Cao
Senior, Advisory Services
Grant Lin
Senior, Advisory Services
4 EY Greater China Consumer Products and Retail Sector Journal |
Introduction
China’s economy is transitioning from three decades of
manufacturing and infrastructure-led growth to a
fundamentally new growth model driven by consumer spending
and services. Growth in discretionary income is rapidly
spreading from large coastal cities to hundreds of urbanizing
cities across the country, bringing unprecedented
opportunities for consumer product companies. But with these
market opportunities come enormous sales and logistics
challenges. To enable profitable growth, consumer products
companies need to align sales growth aspirations with
innovative operating models featuring complex distribution
channels and logistics solutions.
EY has identified five major trends that will shape the
strategies of consumer products over the next three to five
years.
4 EY Greater China Consumer Products and Retail Sector Journal |
5 EY Greater China Consumer Products and Retail Sector Journal |
Shifts in modern retail changing consumer behaviour and
trade practices
Today’s Chinese consumers have abundant product choices
and use diverse channels to spend their hard earned income.
While e-commerce is an important emerging channel,
accounting for 12% of total retail sales, it is new store
formats such as convenience stores and supermarkets that
are driving sales. Between 2000 and 2010, traditional
formats such as independent retailers and discounters had
higher growth levels than supermarkets, hypermarkets and
convenience stores. In just five years, the situation reversed:
supermarkets, convenience stores and hypermarkets showed
rapid growth from 2010 to 2015 while the growth of
traditional retailers is stagnating or even declining. Based on
EY experience, however, in China’s fast moving markets
these numbers do not tell the whole story. In the past year,
we have observed some hypermarkets coming under
pressure and slowing their growth plans.
China grocery retail growth rates by format,
2000 to 2015 3, 4
Grocery Retail Format 2000-2010 2010-2015E
Hypermarkets 15.4% 37.9%
Convenience stores 12.6% 23.3%
Supermarkets 9.9% 22.3%
Food, drink and tobacco outlets 15.3% 12.0%
Traditional discount outlets 13.7% 0%
All grocery retail 9.1% 11.3%
More than ever, busy Chinese consumers are looking for
convenience. Convenience stores in high-traffic areas and
neighborhoods are growing rapidly. In 2014, there were
more than 4,000 convenience stores nationwide. Based on
rapid growth rates of China’s leading convenience store
operators, mainly based in the east and south, EY
anticipates continued growth in the coming years.
Convenience store operators, such as Sinopec Group’s
Easyjoy with nearly 24,000 stores in 2014 and
PetroChina’s uSmile with 15,000 stores, are increasingly
important channels for consumer products companies
battling for valuable shelf space.
Rapid urbanization and disposable income growth in
hundreds of cities
China’s new consumers with ample discretionary income
are no longer confined to “tier1 and 2” cities in the coastal
provinces of China. Based on the government’s extensive
2014 household survey covering 660 cities and rural
regions, national per capita disposable income now exceeds
20,000 yuan, growing by 8% in real terms from 2013 to
2014. Between 2010 and 2014, urban disposable income
grew by 50% and rural incomes doubled1.
Of the top 20 provinces EY ranked by disposable income, 9
are in eastern provinces with a total population over 500
million. Beijing, Shanghai and all of Guangdong ranked first,
second and seventh respectively in disposable income, but
represent only 11% of China’s total population. Hundreds of
large and small urbanizing cities in eastern and central
provinces now have sufficient consumer spending power to
become attractive customers for consumer product
companies. In fact, in 2014 over two-thirds of fast moving
consumer product sales were outside of Beijing, Shanghai,
Guangzhou and Shenzhen. With China’s total retail sales of
consumer goods exceeding 26 trillion yuan in 2014,
companies can no longer afford to focus on established
coastal cities without clear sales and logistics strategies to
take advantage of China’s next wave of consumer growth2.
Major Trends Shaping China Sales and Logistics Strategies
1
Rapid
urbanization
and
disposable
income
growth in
hundreds of
cities
2
Shifts in
modern
retail
changing
consumer
behavior
and trade
practices
3
Evolving
sales and
distribution
channels to
reach
China’s next
wave of
consumers
4
Surging
e-commerce
sales
transforming
channels and
consumer
behavior
5
Investments
in modern
logistics
enabling
broader and
lower-cost
geographic
coverage
6 EY Greater China Consumer Products and Retail Sector Journal |
China’s Evolving Sales and Distribution Channels
Surging e-commerce sales are transforming channels and
consumer behavior
E-commerce in China is booming as urban and rural
consumers across the country take advantage of
unparalleled access and convenience to endless choices of
international and Chinese consumer products from fresh
food to trendy electronics.
In 2014, e-commerce sales reached 3.2trillion RMB,
accounting for 12% of total retail sales. E-commerce sales
are expected to more than triple to 10.7trillion RMB within
the next three years, accounting for 29% of total retail sales
by 20186.
Alibaba, JD.com and other e-commerce players are
investing heavily in logistics infrastructure and services to
reach consumers whether in the largest cities or smallest
rural villages.
For example, Cainiao, the logistics subsidiary of Alibaba, has
recently launched three fresh food distribution centers to
provide cold chain delivery services within 24 hours to 18
cities with plans to expand to 50 cities by the end of 20157.
JD.com owns and operates seven fulfillment centers and
166 warehouses in 44 cities across China. Complementing
this logistics backbone are 4,142 delivery stations serving
over 2,000 counties and districts across the country8.
While it remains to be seen how the logistics of e-commerce
companies will evolve, this much is clear: the rise of e-
commerce will fundamentally alter today’s traditional sales
channels and how consumer products companies engage
with consumers.
In China, the number of convenience stores per million
populations is only 54, compared to 388 in Japan and 425
in Taiwan5. Companies should therefore look to these and
other markets for inspiration, but their models will need to
be adapted for China’s unique sales and operating
environment.
To tap into the growth of convenience stores, many
consumer products companies will require new sales and
logistics strategies – including national direct sales
coverage, decentralized warehousing, and flexible fleets for
multiple deliveries each day.
Sales and distribution channels are evolving to reach
China’s next wave of consumers
Most consumer product companies have historically relied
on traditional multi-layer channels to reach more
consumers, minimize operational complexity, and reduce
working capital requirements. However, the emergence of
modern retail and e-commerce is challenging the landscape
for consumer product companies, distributors and retailers
alike. Hybrid models are rapidly emerging as companies
work to broaden national coverage, get closer to consumers
and expand into e-commerce. While the trend towards fewer
and fewer distribution layers is clear, EY expects the
evolution to be a gradual one as consumer product
companies consider the advantages and disadvantages of
different channel structures for distinct product, markets
and geographic segments. Tapping into lower tier cities, in
particular, will likely continue to require traditional multi-
layer distribution channels.
To succeed, consumer products will need to excel in
managing operating complexity. Sales strategies and sales
force effectiveness must be refined, sales channel and
distributor partnerships deepened and, importantly, the
right logistics infrastructure must be in place to support
sales growth.
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GLP, with the largest warehouse space in operation in 35
cities, is one of the leading providers of modern logistics
solutions to end users. It has total 11.8 million square
meters of warehouses in operation and 21.8 million square
meters under construction or in land reserve. Its continuous
investment in China will keep its market leader position in
the logistics warehouse space. Blogis is the second largest
modern warehouse provider in China with 1.4 million square
meters warehouse space in operation. It plans to add 0.72
million square meters of space per year in the next five
years to reach 5 million square meters9.
BPHL is focusing on cold chain and bonded logistics
services. It currently has 5 warehouses in operation and
plans to add 0.3 million square meters of space per year in
next five years9. Besides BPHL, China Merchants-Americold
is also investing in new cold storage facilities with capacity
of 50000 tons12. Swire Group has 4 cold storage
warehouses currently in operation with a total pallet
capacity of 137,000. It also plans to invest in 13 modern
cold storage facilities by 2020 to serve 2/3 of China’s
population13.
EY anticipates that ongoing investment in logistics
infrastructure will be a key enabler for greater sales
expansion. Cold chain, particularly, will outperform other
sectors as the new highlight. The fast development of
infrastructure will provide consumer products companies
with an ever broader customer reach and at increasingly
lower cost.
Investment in modern logistics infrastructure and services
enables broader and lower-cost geographic coverage
Strong sales growth of consumer products drives the need
for modern logistics infrastructure and services. Today,
China’s logistics industry remains in the early stages of
development – only 11% of China’s warehouses are up to
global standards. This is driving significant investments and
plans by specialized logistics companies, e-commerce
companies and other investors. Global Logistics Properties
(GLP), as a leading logistics developer, has 10 million square
meters of warehouses under development. The second
largest modern warehouse player, Blogis, plans to expand
its current warehouse land bank to 5 million square meters
by 2019. Beijing Properties (Holdings) Limited (BPHL) aims
to manage 3 million square meters of warehouses by 20199.
Furthermore, EY have seen significant investments being
made in cold chain infrastructure. In 2014 alone, total
investment in cold chain infrastructure exceeded 410 billion
RMB, with nearly 25% for the construction of 40 cold chain
logistics parks10.
Shun Feng Express (SF), one of the leading companies in
express delivery in China, owns 91 warehouses nationwide
with a total capacity of 0.75 million square meters. It
operates over 12,000 service centers and approximately
16,000 vehicles across its broad China network and plans to
open a major cold storage hub in Wuhan in 2016. Once
finished, it will serve as a central network covering 6 major
regions within the radius of Beijing, Shanghai, Guangzhou,
Xi’an, Chengdu and Xiamen11.
8 EY Greater China Consumer Products and Retail Sector Journal |
References:
1. China’s Economy Realized a New Normal of Stable Growth in
2014, 2015, www.stats.gov.cn
2. Annual per capita disposable income of rural and urban
households in China from 1990 to 2013 (in yuan),
www.statista.com
3. Average annual grocery retail growth rate in China from 2000
to 2010, with a forecast until 2015, by type of store,
www.statista.com
4. Total sales of Commodities of Integrated Retail Report,
www.stats.gov.cn
5. Development report of China convenience store 2014,
www.ccfa.org.cn
6. China to Become Largest E-commerce Market in 2015, 2015,
www.chinainternetwatch.com
7. Cainiao Launches Three Fresh Food Distribution Centers,
www.alibaba.com
8. Tmall, Yihaodian and JD: A Comparison of China’s E-commerce
Platforms for Foreign Enterprises, 2015, www.china-
briefing.com
9. Industry Focus-China Warehouse sector,2015, DBS
VICKERS SECURITIES
10. Review of Chain Cold Chain Development in 2014,
www.cnlenglian.com
11. Introduction to SF Express Co., Ltd. 2015
12. China Logistics and Purchasing, 2010, www.cnki.net
13. Swire Group Introduction, www.spcschina.com
Conclusion
Consumer products companies looking to tap into China’s
next wave of consumers will require the right sales,
distribution and logistics strategies to ensure profitable
growth. While the broad trends are clear, company
strategies will need to be adapted regionally, and even
within cities, to account for significant differences in the
distribution practices and logistics infrastructure across the
country.
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New Integration Era for Consumer Products and Retail Sector in China
Hsuan Chen
Executive Director
Transaction Advisory Service
10 EY Greater China Consumer Products and Retail Sector Journal |
“A dream Market”
According to the 2014 data released by the National Bureau of
Statistics of the People’s Republic of China, China currently has
around 1.4 billion people (~19% of the world’s population), 200
language dialects and 57 ethnic groups. ‘The China market’ has
become a crucial engine of global growth – a dream market.
Almost half of all survey on 2011 found that many global
companies had raised their expectations for China after the
2008 financial crisis.
Although China’s economy slowed to 7.4% GDP growth in 2014
– the lowest rate since the 1990s, China remains among one of
the top 10 fastest growing economies in the world.
10 EY Greater China Consumer Products and Retail Sector Journal |
11 EY Greater China Consumer Products and Retail Sector Journal |
However, based on Bain and Kantar Worldpanel's study,
Winning Over Shoppers in China's ‘New Normal', the overall
China market growth for consumer product and retail
(“CPR”) categories is showing a continued deceleration
from nearly 12 percent in 2011-2012 to 4.4 percent during
the first quarter of 2015.
The report also indicated that in China's lower tier cities,
the impact of the slow-down was minimal – 8 percent in Tier
1 cities vs. 2 percent in Tier 2 cities.
With the shifting market dynamics, multinational companies
(MNCs) in the CPR sector today face a range of new
challenges in the China market:
► Strong competition from local players: In China’s CPR
market, MNCs competitive advantages are eroding due
to the strong local competitors. There are two types of
Chinese competitors: (a) powerful state-owned
enterprises (“SOE”) with government background, and
(b) highly competitive and dynamic Chinese-owned
companies
► Changes in behavior: Consumers are now becoming
more flexible in brand loyalty, shopping habits,
preferences, and media consumption. Furthermore, e-
commerce is beginning to reign supreme in China.
Online shoppers have expanded their purchases from
high-priced products to categories with lower average
selling prices
► Difficulties to penetrate into lower tier cities: Foreign
CPR companies face a set of challenges as they expand
into less developed areas: limited knowledge of local
markets, insufficient infrastructure and poor distribution
channels, and cultural differences. Private label
competition from retailers is also playing a road block to
MNCs
MNCs in the CPR sector are essentially competing with local
rivals that have lower costs and stronger distribution
networks in China.
Chinese brands are the leaders in China
Kantar Worldpanel’s 2015 Brand Footprint ranking reveals
that the top CPR brands in China are Chinese brands or
brands with Chinese origins. The ranking was established
based on a metric to indicate frequency and location of a
brand being consumed by Chinese consumers.
According to the report, the top three players - Master
Kong, Yili and Mengniu - were chosen by Chinese shoppers
more than 1 billion times in 2014. Among the top 10 brands,
Shuanghui, Bright and Haday have also advanced in the
ranking from 2013.
Rank Name of the company % of penetration Frequency
1 Master Kong 90.2 8.8
2 Yili group 88.1 7.7
3 Mangniu Group 87.6 7.4
4 Want Want China 73 5.4
5 Shuanghui Group 65.6 5
6 Bright Food Group 47.5 6.8
7 Unit president China
Holdings LTD 68.7 4.7
8 Wahaha Group 63 4.5
9 Haday Group 64.5 3.9
10 Liby group 67.8 3.7
In the market, local brands have been strengthening their
engagement with consumers by providing both online and
offline promotions, and by promoting propositions of
convenience, quality and a healthy lifestyle.
In response, Chinese consumers, with their increased
disposable incomes, are more willing to buy high quality and
innovative local brands. Chinese brands have apparently
outpaced a number of major global names in the past few
years.
12 EY Greater China Consumer Products and Retail Sector Journal |
Newly formed business circumstances
In a country where local brands are generally reacting faster
to the market changes, MNC brands need to develop a higher
level of agility. However, MNC operations, particularly for
those global names, commonly do not allow rapid changes to
their strategy.
First of all, it is very typical for MNCs to have complicated
and long decision-making metrics and processes. Various
levels of leadership must approve the new products or
strategies. And by the time they come to introduce a new
product or a marketing strategy, it may have already been
launched or adopted by a local competitor.
Secondly, in the growing remote areas of China, distribution
assumes an even greater marketing significance. Local
brand growth comes from concentrating on outlets in lower
tier cities where global brands are less likely to be found.
Chinese toothpaste brand Saky, for instance, has grown by
being well-distributed and highly visible on local store
shelves.
Additionally, MNCs now do not appear to have the advantage
of attracting the top talent, and it is even harder to recruit
talent in remote areas to help penetrate the market. HR
consultancy reports reveal that the local talent is
increasingly gravitating towards mainland companies.
So how can CPR MNCs survive in China going forward?
A new business culture is emerging!
In the past few years, we have seen the best local know-how
and entrepreneurial skills combine with western managerial
expertise. MNCs either form a joint-venture with a Chinese
company or directly acquire a local brand. The objective of
the transaction is no longer a “full take-over”; instead, a
“Best of Breed” approach has evolved, i.e., ensure the best
of both companies is retained.
Integrate the “Best of Breed”
In the context of a transaction, "Best of Breed" is a
strategy of selecting the best practices of the acquirer and
acquiree, rather than selecting one large integrated
solution from a single entity. We have now seen this
principle widely adopted by MNCs: from their M&A strategy
planning to post-deal integration.
In these cases, deals give the MNC access to the edges of a
domestic player such as important government contracts,
upstream activities, intellectual property (“IP”)
contributions, distribution channels, and core capabilities
sharing, and other means of advancing in China.
But finding the right acquisition candidate is just the
beginning: The planning and execution of integration can
make or break a deal.
Historically, post-deal integration has been considered as
“changing” and “restructuring” the acquired business. The
objective was mostly narrowed to “operational alignment”
instead of focusing on “value creation”. It is like a married
couple busy at setting out the house rules rather than
creating family values after signing that piece of paper.
13 EY Greater China Consumer Products and Retail Sector Journal |
► Create a brand image with affordable price but high
MNC quality:
Due to their increasing disposable income, Chinese
consumers are able to trade-up from the low-end
products they previously purchased. At the same time,
higher-income consumers are moving away from pricey
foreign brands and accepting less expensive, locally
produced alternatives that have reasonable quality.
► Develop innovative products by using local resources of
the acquired company:
New pathways to innovation are made possible for
MNCs by leveraging core strengths derived from the
country-specific capabilities of the acquired company.
These opportunities enable MNCs to lower their cost
structures, enhance their innovation capabilities, and
generate more revenue and profit by acquiring a local
cutting-edge company.
Now, as they are facing rivals scattered across China, MNCs
no longer only focus on operational stabilization and finance
controls during the integration. Savvy acquirers are taking
action to design an explicit and pragmatic integration blueprint
which will enable the new organization to be more than the
sum of its parts.
Essentially, MNC players in the CPR sector should focus on
five areas during their post-deal integration:
► Leverage the extensive local distribution network of the
acquired company: While higher-tier cities are fairly mature
markets for players both domestic and foreign, Chinese
companies often have superior sales channels in the faster-
growth, lower-tier cities
► Quickly equip a salesforce with an integrated portfolio of
brands:
Commonly the products for a foreign CPR brand are high-
end and more expensive. MNCs can consider creating a
merged product portfolio to make efficient of the mid to
low-end products of the acquired company attracting new
customers and channels.
► Adopt localized marketing and branding strategy:
The Chinese CRP market is very fragmented and
regulations may not be sufficient to deter certain unlawful
competition. Marketing and branding strategies
successfully realized in western countries may not have
the same effect in China. A leading European furniture
company is a good example in localizing its marketing and
branding strategy. Firstly the company is leveraging
Chinese social media and micro-blogging website Weibo to
target urban youth. They have also adjusted their store
location strategy: The company established its outlets on
the outskirts of cities which are connected by rail and
metro networks. This allows the local people to access
their stores by public transportation.
14 EY Greater China Consumer Products and Retail Sector Journal |
Conclusion
It is imperative for an MNC in China’s CPR sector to work
with a local company when attempting to lower costs for
both domestic production and export, and when trying to
fill portfolio gaps, expand the distribution channel, and
provide high-quality innovative products to impress the
consumers.
However, this cannot be achieved by just selecting a
leading local company and letting it run separately. It’s
essential now to maintain the edges of the acquired
company, to secure the deal value, and to combine the best
from the two.
As China is a market which cannot be neglected, MNCs
should prepare to take advantage of the increasing
capabilities of local companies and to capture the benefits
garnered from transactions. The most experienced
acquirers will bring a tailored approach to integration, and
be savvy enough to adopt the local marketing strategies,
and ensure financial control - but without slowing the
operations of the acquired company.
Recent cases
Several major CPR MNCs appear to be growing their market
shares by following the “Best of Breed” approach.
A world-leading consumer goods supplier acquired a
majority stake in its Chinese competitor in 2014, the largest
acquisition by the company in China in over a decade.
According to the company, the deal doubled the size of their
targeted business in China and will bring together
complementing technology from both sides. In the
meantime, the MNC can leverage the acquired company’s
local marketing insight, manufacturing and distribution
strengths.
The deal is expected to bring together innovation,
technology, design and manufacturing capabilities. Each
company has a broader range of product portfolio in the
targeted business that covers a range of performances and
price points. Hence the “Best of Breed” integration focus
was to bring together the better aspects of the two in the
areas of distribution channel, manufacturing, R&D,
marketing strategy, and people.
Another world-leading MNC company, a cosmetics maker,
also made an astute investment: The company acquired a
leading Chinese company in 2013 to expand in a market
where sales growth had been outpacing that of the
company.
The acquisition has helped the MNC gain access to the
consumers over which the domestic companies have a
better hold: the low-end to mid-range ones. Rigorous
planning of the portfolio of brands and products is the key
post-deal.
15 EY Greater China Consumer Products and Retail Sector Journal |
Digital Luxury strategy capturing the Chinese mass market
Lilly L Cheung
Senior Manager, Tax Services
16 EY Greater China Consumer Products and Retail Sector Journal |
11-11…12-12… What’s next? These numbers are imprinted in
the minds of every shopper and company operating in China. According to Chinadaily, the renowned China ‘Single’s Day’
sales in 2015 resulted in $14.3 billion, of which over 70% percent of the volume was generated from mobile channels, such as smartphones and tablets. (Source: China Daily, Dec 18, 2015, http://www.chinadaily.com.cn/business/tech/2015-11/11/content_22427826.htm)
This is already a sign that a mobile flagship store should be even more geared up standing out on these magical days of the year, as 11-11 has proven in success cases, to generate 4 months of physical store sales. Yet the rumor was over 50% of all purchases were returned due to inferior quality. (Source: 中国商业报道网 December 3, 2015)
16 EY Greater China Consumer Products and Retail Sector Journal |
The paradox has been should luxury adapt to the digital world? If eCommerce is the secret weapon to save luxury brands from losing market shares or public interests, what is then the success road for a digital luxury strategy?
In order to have an in-depth understanding of eCommerce business in China, EY’s Operating Model Effectiveness group interviewed 33
companies in mainland China between April - August 2015 and investigated the digital market strategy, operating model, and operational transformation needs, of the retail, apparel, luxury, super- and hyper-market, and food chains in a first phase, with a deep dive in the luxury sector in a second phase as they were either not playing or playing a different ballgame.
1
2
3
4
There is a mix of commercial, operation, tax and legal considerations for setting up a sustainable and profitable eCommerce business in China.
► How does the online market look like?
The industries have been plotted in the graph based on the interview results. The following graph was the result of the conducted research. The vertical axis describes the online market share as part of the total market share of a company. The horizontal axis describes the online customer base.
Four digital strategies
Self-owned webshop
3rd party owned webshop
no webshop
Slow movers refer to the industries, i.e. super/hyper
markets and large retailers, in the lower right quadrant.
They have websites presenting their products and services
as they gradually build new delivery options. The DCs and
logistics network are in place and, sometimes, they also sell
their company-branded products.
Strategy: Slow movers in mainland China are renewing their
eCommerce strategies; increasing their capabilities in
marketing, IT and logistics; and upgrading their existing
eCommerce platforms. The next step is to provide their
online shop with more O2O delivery options such as home
delivery, store and DC pickup.
In order to increase customer traffic and influence buying
behavior, large companies look for ecosystem-
complementary collaboration partners to increase their
product portfolio. They form alliances with large merchants,
integrate their systems and build consistency across the
different sales channels. Their strategy focuses on shifting
upward in our model by adding up the market share of other
large companies through collaboration. Arrow #2 in the
graph above
► Bold movers’ strategy: Navigate members through O2O
experience
Bold movers refers to the industries where services plays an
important role, i.e. food chains and luxury brands, in the
lower left quadrant in the graph.
Customer centricity is key in the digital strategy. In
particular, the barriers for luxury brands to enter
eCommerce is based on the assumption that they lose the
customer because of the fact that eCommerce will create a
lower customer experience. This positive experience is
essential to demand premium prices. They seem to use “trial
and error” to create a “buzz” derived from a bold move, like
Chanel with the global pricing alignment and the launch of
Cartier’s eCommerce platform without any advance
announcement. They both created the talk of town this
year.
Strategy: A flawless online-offline experience, triggered by a
“buzz” is an important part of enticing a customer to make
an impulsive buy. Their digital strategy is shifting up and to
the right. See arrow #3, where the bold movers work
together with other companies to enhance the customer
experience.
Based on the 33 research results, a remarkable observation
is that all players try to design their own mass market
strategy, and the luxury brands are the only group that
focus on the customer experience journey. This is the
reason why we took a closer look into Luxury brands in the
remaining part of this article.
In general, most companies in the dark grey colored circles
have their own platform. The yellow colored circles are
available on a third party eMarketplace. The light yellow
colored circles have a relatively lower eCommerce
marketshare, and are either on an eMarketplace or not
available on eCommerce.
The chosen strategies within the industries in the scope of
this research can be divided into four groups:
► Early movers’ strategy: Maximize traffic and explore new
markets
Early movers refer to the eMarketplaces, depicted in the
upper right quadrant in the graph. They were the early
movers in the Chinese eCommerce market and consequently
have a high online market share and a large digital customer
base. They now are used like search engines, and provide
convenience, low-priced commodities and fast delivery
services.
Strategy: their strategy is based on the fact that they want
to stay in this quadrant. In order to achieve the high level
online market share and customer base, they have to
activate online traffic through increased and complementary
offerings and increased coverage. They expand their
logistics hubs and network to lower tier and rural mainland
China, and acquire new innovations faster than their
competitors.
► Fast movers’ strategy: Create a brand-presence on a
third-party platform and attract traffic
Fast movers refer to the industries, i.e. scalable retailers and
apparel companies, in the upper left quadrant in the graph.
They sell products through eMarket places created by the
platform giants. However, their (online) customer base is
still relatively low.
Strategy: They try to upsell themselves by brand building
through differentiation strategy, to ‘stand out from the
crowd’. Their challenge is the fact that they are dependent
on the eMarketplaces, they have relatively low negotiation
power, and limited information on the new group of
customers that are diverted to then through the
eMarketplaces. They want to shift to the right in the graph
above. See arrow # 1 in the graph
► Slow movers’ strategy: Activate existing clients through
online-to-offline (O2O) collaboration with ecosystem-
complementary partners
18 EY Greater China Consumer Products and Retail Sector Journal |
The key finding #1: is that ‘the digitally
conservative’ luxury brands focus on a ‘seamless
customer experience journey’, while ‘the digitally
mad’ focuses on ‘convenience, fast, and cheap’.
What obstructs Luxury brands to follow the digital
madness?
► Image: Online shopping is seen as shopping on a market
place for cheap buys, fast and conveniently. This can
damage the luxury image
► Touch point: Loosing the contact with the customer who
is eager to receive special treatment in physical shops
► Governance: The behavior of third parties with the
customer is uncontrollable, especially in the last mile
delivery where a third party logistic provider is having
the touchpoint with the customer
► Grey market/fake/daigou: Luxury brands do not wish to
be associated with fake goods being sold on the eMarket
places through unauthorized channels. Legal action is an
important way of fighting counterfeiting
► IT and supply chain capabilities: Digital that heavily
leverages the marketing, customer services, supply
chain and IT functions of a company, are only partly in
place with luxury companies. Luxury brands in China
mostly have their supply chain and IT outsourced. They
have the challenge whether to build these capabilities
for the longterm and/or having their own luxury online
platform
► Pricing: eCommerce triggered global transparency on
product information and the pricing. Luxury brands,
eMarketplaces, flagship stores on and offline, have to
consider global pricing alignment, in order to balance
brand’s omnichannel strategy. There are doubts on how
the retail price can be balanced with the internal
transferprice between different entities, and ensuring
shareholder value is maximized
► Tax: Bonded logistical crossborder eCommerce zones
are popping up in different provinces to attract foreign
investment. Import duties on luxury goods are changing,
therefore, how sustainable is the operating model
The key finding #2: The current offline market is
saturated. In order to grow, exploring the online
market is a must as digital is the only way to reach a
larger market share of both on and offline
customers.
How should you change your organization as an effect of
‘going digital’?
The organizational change has been lagging behind the
customer behavioral change.
Companies are renewing their eCommerce strategies and
considering essential strategic choices regarding the main
functions within the company. One of these choices is the
decision on which new capabilities to be built in-house for
the future.
The continuum depicted below, shows the amount in
investments and business impact in needed capabilities to
be built from scalable to large companies. The focus is on
the four type of strategies indicated earlier. In principle,
there is no difference in terms of optimum situation
between small and large firms, however, clearly large
companies have the resources to make needed choices
easier to provide customers the O2O experience.
This continuum shows that all companies should at least
strengthen their marketing and their innovation
department,that leverages social media to improve the
customer stickiness. Acquiring a new eCommerce customer
and good customer retention, can enlarge the life time
customer value that generates an extended turnover (for
lifetime). IT and supply chain are areas that companies have
to build inhouse, the more they grow online.
19 EY Greater China Consumer Products and Retail Sector Journal |
Organizational capabalities development
What obstructs Luxury brands to follow the digital
madness?
Capabilities build inhouse versus outsourcing:
A. IT: big data analytics to achieve predictive modeling and
personalization
B. Supply chain logistics: increased control on quality at
touch points with the customer in the “last mile
delivery,” improved vendor management
and omnichannel logistics, reorganization of DCs and
physical store inventory
C. Marketing: brand and online content management
D. Customer service: improved training and personalization
in product as well as customer knowledge
E. Innovation/ social media: transforming innovative
branding ideas and delivering this through an
omnichannel
The answer of which are the different functions that need to
be developed inhouse, depends on the level of maturity, the
industry and the size of the company.
eCommerce Maturity in China
Merchandizing
and pricing
Price
determination
Digital asset
production
Product
listing
Customer
services
Order
processing
Inventory level
determination
Warehouse
location
selection
Order and
inventory
Inventory
replenishment
Boldmover
Boldmover
Fastmover
Fastmover
Fastmover
Slowmover
Pioneer
Growth
Saturation
Market-entry
eCommerce
MATURITY
Merchandizing and pricing Operation & sales Inventory management
Order
handling
Pick and
pack
Shipment Return
goods
handling
Tax and
customs
declaration
Data
analytics
and
reporting
Brand
communica
tion
UI design Search
engine
marketing
Marketplace
promotion
activities
Search
engine and
social
media
Online
media
relationship
Online /
offline
marketing
campaign
Brand site
development
Hosting and
maintenance
Source code
ownership
Boldmover
Boldmover
Fastmover
Fastmover
Fastmover
Slowmover
Pioneer
Growth
Saturation
Market-entry
IT-related
eCommerce
MATURITY
eFullfillment Marketing-related
20 EY Greater China Consumer Products and Retail Sector Journal |
Based on the EY research, the companies in different
maturity phases show changes in inhouse organizational
capabilities. This table can only be seen as a benchmark and
reference. For luxury brands, the bold movers, you see that
merchandizing, pricing and mostly the marketing related
activities should happen in house, at least for the strategic
decisionmaking. However, if we look at the other groups,
fastmover, slowmovers and pioneers, there is an
operational transformation need in order to execute the
digital strategy. The transformation relates in this case in
the choice in-house versus outsourcing.
Companies do merchandizing and pricing always inhouse.
► Market entry phase: functional activities that can be
outsourced through eMarketplace are the online
operations, order taking, sales, order replenishment
► Growth phase: Logistics and IT can mostly be
outsourced, however, the more the companies grow
online, the more functions should happen inhouse.
Marketing is a function that should be strengthened, but
will always remain a collaborative effort, where the
decisionmaking happens inhouse and the execution
happens with third parties. Nevertheless, big data should
in all cases be generated inhouse in order to better
predict company’s key customer behavior
► Saturation phase: During this phase, all organizational
capabilities should be built in house already. In logistics
and IT, there are limited companies that make use of
third parties
The key finding #3: ‘Going and being digital’ means
the key drivers and touchpoints with customers
should be controlled.
The organizational capabilities being impacted are mainly
marketing – to attract the customer; supply chain should be
restructured (previously you sent a batch to the store, now
you send 1 item across China); customer service to deal
with returns and questions that could be prevented when
the items was bought online; IT capabilities to integrate the
different systems to ensure one view of truth of the order
(i.e. integrating the system of the web and mobile portal,
the order management system, with the warehouse
management system and the logistics provider system).
Customers strategies diverge; buy cheaper and buy more
luxury. Customers that have access to global pricing, save
money through buying online, mainly through
eMarketplaces. This additional saving can in turn be used to
buy luxury goods in order to upgrade themselves for their
image and pride.
Company strategies converge; Companies that pursued the
mass market previously, are trying to ‘upsell’ their brand,
since the new digital customers from lower tier cities, might
just learned about the brand. Luxury brands introduce new
lines that are capturing the new online market customers, in
order to prevent ‘downselling’ their original brand. Luxury
exclusive is no longer defined as scarce, but characterized
as having a long unique authentic brand story of
craftmanship. Other
A digital strategy for luxury brands has two implications for
the companies operating in this industry. First, the need for
consumer centricity and the need to govern consumer
experience especially in the touchpoints, makes it necessary
to build in house capabilities much more than in other
sectors. Secondly, and related to this, there is high urgency
to make resources available to invest in these in-house
capabilities.
21 EY Greater China Consumer Products and Retail Sector Journal |
We present our key considerations as follows according to
the key constraints and feasibility of market entry: Legal,
Advisory, Tax (Customs, China tax, and transfer pricing).
Can we and how to set up ecommerce in china legally?
Legal
► Legal structure: Can the brand make use of their own
WFOE to set-up eCommerce or should they set-up
eCommerce with a Chinese partner? How should the
holding structure look like?
► License to operate: Does the brand need to register or
file for an ICP license with the Ministry of Internet
Information Technology? This is based on the province
where the eCommerce platform is located whether they
define the brands’ online activities as ‘commercial’
Internet Information Service (IIS) activity. The definition
of ‘commercial’ differs between the 30 provinces in
China. What registrations does the brand and/or the
distributor need to get?
► Material limitations: What products can be imported into
China, which and how to apply for these licenses?
► Sustainability: What are the legal requirements to ensure
the O2O Operating model in China is sustainable
What and how to set up ecommerce from business
strategy and operational feasibility point of view?
Advisory
► Brand image: How to localize while maintaining your
brand image? How to recruit talents with brand
experience and innovate on the brand?
► O2O strategy: How to bring a seamless online and offline
experience to a customer in China? Competitors are
setting up O2O in lower tier cities, should brands follow
this pattern?
► Big data/ eCRM: How to use big data analysis to
personalize and predict customer preference? How to
engage customers through different online and offline
channels?
► Channel strategy: Should brands choose to have their
webshop on their own brand site, a third party
eMarketplace, or a wechat - shop? Should brands choose
to have a mobile app? Which social media channels
should brands be on in China?
► Sales: How to drive Chinese customer traffic online?
How can brands convert online traffic into sales?
► Pricing strategy: How to globally align prices with
distributors on and offline, and with transferprices?
► Products strategy: Which products should brands put
online and which one offline? What do other brands do?
► Inhouse /outsourcing: Should brands operate the
eCommerce themselves or should they outsource part of
this? What is the balance?
► Logistic and supply chain model: Should brands make
use of a third party warehouse? If yes, from a sales
distributors’ or a logistical provider? Should this
warehouse be located in a Free Trade Zone? Should this
be a bonded warehouse setup or a local warehouse?
How to organize the return logistics through on and
offline channels. How to improve the touch points with
the customers on their last mile delivery?
► Inventory management: Should you integrate your
inventory management of your online and offline
channel? How to have real time visibility and governance
of inventory between physical store DCs and other
central DCs in or outside of China?
► Payment: Which payment provider should brands make
use of? What options are there to integrate local
payment providers into brands’s current system and
eCommerce platform?
► IT strategy: Should brands leverage their existing
eCommerce platform or build a local platform? What is
the best location to place the server? Can the server be
placed on a tax efficient location? How to guarantee
data safety?
22 EY Greater China Consumer Products and Retail Sector Journal |
What and how to set up ecommerce from a tax compliance
and efficiency point of view?
Transfer Pricing
► Intangible assets: What intangible assets (e.g.,
trademark/brand, trade name, technology, know-how,
eCommerce platform, etc.) will be deployed in carrying
out the eCommerce business in China?
► Ownership of the intangibles: Which entity performs the
developing, enhancing, maintaining, protecting,
exploiting and promoting of the intangible assets
deployed in the China market and bears the relevant
costs?
► Local marketing-intangible: Which entity is responsible
for determining the marketing strategy in promoting
brands/images in the China market? Which entity is
responsible for executing these strategies? What
activities are performed by these entities?
► Value chain: What is the functional profile (e.g., from
limited risk to full-fledge)? How does each entity position
themselves in the value chain related to the eCommerce
business in China?
► Transfer pricing policy: What related party transactions
will be engaged by each entity related to the eCommerce
business in China? What are the possible charging
mechanism (e.g., royalty, service, commission, etc.)?
How can brands determine the relevant pricing policy?
How to import and set up the warehouse tax efficiently?
Indirect Tax (Customs/VAT)
► Free Trade Zones (FTZ): Brands have branches in
Chinese cities where Free Trade Zones have eCommerce
incentives. Where should brands set up eCommerce in
China?
► FTZ partners: What registrations should brands and
related online partners i.e payment firm, logistics
enterprise, operator of customs supervised areas, make
with the customs authorities to store/import/sell
branded products?
► FTZ Warehouse: Should brands use a bonded warehouse
from a third party provider of build their own
warehouse?
► FTZ Incentives: How can brands leverage the Free Trade
Zone incentives? Is the tax preferential treatment for
the eCommerce business in the Free Trade Zones? Is the
financial subsidy for the eCommerce business in the Free
Trade Zones applicable?
► FTZ Procedures: What are the required standard
procedures to set up the eCommerce company in the
Free Trade Zones? How should we report the 3 flows
information (cash flow /sales flow /goods flow) be
reported to Customs authorities correctly and timely?
How to ensure the reporting of import information, e.g.
item name, price, quantity, HS codes and etc. to
Customs authorities happen correctly?
► FTZ Tax implications: What are the tax implications of
conducting the eCommerce business in the Free Trade
Zones? Are there other considerations from China tax
perspective the management should be aware of?
► Free Trade Agreements: Have the free trade agreements
been utilized to mitigate duty rate with appropriate
supporting documents for products imported into China
from oversea?
► Regional Customs polices/practice: As eCommerce is
permitted in 9 pilot cities, some selected free trade
zones and pilot zones/areas, which may be under
different regional customs authorities in China, does
brands have approached these Customs offices to
understand the regional customs policies and practice on
eCommerce model requirement and imported goods?
► VAT implications: What are the VAT implications of
selling to private consumers?
23 EY Greater China Consumer Products and Retail Sector Journal |
How to structure tax efficiently?
General China Taxes
► Permanent Establishment (PE): Will brands create a PE
in China under the new business structure especially
eCommerce in terms of the location of the ‘Server’?
► Treaty Protection: Are brands qualified for treaty
benefits? How could brands mitigate those challenges
from different perspectives (i.e. contractual terms,
origination and negotiation, execution,
management/authentication, title transfer, income and
etc) on eligibility of enjoying the treaty benefits? What’s
the application procedure?
► Impact of BEPS: What’s the view of the China tax bureau
on brands’s eCommerce business in China (i.e. funds
flow, goods, services, people authentication, information
and etc) ?
► Consumption Tax: What’s the consumption tax on the
goods of brands? Any opportunity to minimize the
consumption tax which is only taxed on certain goods?
► Withholding Tax Liability: Is brands the tax withholding
agent of the individual consumers who buy products
through eCommerce platform? How should brands fulfill
its withholding obligations?
► The market is transforming due to rapid consumer
behavior change, internet & mobility empowered
consumers. “Go digital Or die” is not just a slogan.
eCommerce strategy determines the operating model.
EY provides a turnkey operating model covering all
functional fields to deliver integrated services.
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and is not intended to be relied upon as accounting, tax, or other
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