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What do Experts Say?

“Ten Highlights of China’s Commercial Sector, 2011-2012”

Li & Fung Research Centre Secretariat of the Expert Committee of China General Chamber of Commerce

20112012年中國商業十大熱點

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Contents

Contents ........................................................................................................................................... 2

Chapter 1 Introduction ....................................................................................................................... 3

Chapter 2 Executive Summary .......................................................................................................... 7

Chapter 3 Implications for Foreign Investors .................................................................................. 10

Chapter 4 Ten Highlights of China’s Commercial Sector, 20112012 ............................................... 13

1. Real retail sales of consumer goods will grow at a slower pace; stabilizing ................................ 13 the economy by expanding domestic consumption becomes more challenging

2. Development Plan for Domestic Trade will set the framework and policy direction ..................... 16 ! "#$!%&'()*+!,#-.+/'0!/$),.!+.0/#$!'(!/&.!(.1/!23.!4.)$+

3. As China’s exports shrink amid global economic uncertainties, ................................................... 18 more exportoriented enterprises are turning to domestic sales

4. Online retailing continues its stunning growth; growing calls for more stringent ......................... 23 regulations, oversight and monitoring of China’s online retail market

5. Building booms of commercial properties may lead to oversupply in the market .......................... 26

56! 7&.!8$#2/!-#,.9!#"!+#-.!9)$:.;+0)9.!$./)'9.$+!'+!<=.+/'#(.,!>4!/&.!8=>9'0?!! ................................. 30 growing calls for the government to improve regulatory environment

7. Pressing need to address the issues of recruiting and retaining .................................................. 32 employees in retail industry

8. Pilot tax reform program on logistics sector sets to strengthen the operating environment .......... 35

9. Increasing supply of governmentbacked wholesale and logistics facilities ................................. 38 sets to lower distribution costs

10. Growing calls to lower business costs for China’s commercial and service sectors; ................... 41 more supportive measures are expected

What do Experts Say?“Ten Highlights of China’s Commercial Sector, 20112012”

Li & Fung Research Centre Secretariat of the Expert Committee of China General Chamber of Commerce3

Chapter 1 Introduction

About the “Ten Highlights of China’s Commercial Sector 20112012”

Today, retail and consumer companies home and abroad are casting their eyes on China, bringing exciting changes to China’s commercial landscape. To gear commercial enterprises up for the opportunities, the Expert Committee of the China General Chamber of Commerce (ECCGCC !"#$%&'()*+,-' ) joined forces with Li & Fung Research Centre (./01!2 ) of the Li & Fung Group for the eighth year to launch the “Ten Highlights of China’s Commercial Sector, 20112012” (the Ten Highlights).

The Ten Highlights, of which selection and dissemination are conducted annually, offers enterprises a comprehensive overview of China’s latest commercial developments. The event achieved tremendous success in previous years and the English reports on the Ten Highlights were highly regarded by foreign media and investors as useful handbooks to grasp the latest commercial issues and trends in China.

Selection of the Ten Highlights

7&.! /.(!&':&9':&/+!#"!%&'()*+! 0#--.$0')9! +.0/#$! "#$! @ABB!)(,!@AB@!C.$.! ',.(/'2.,!)"/.$! )! +.$'.+!#"!voting and formal, indepth panel discussions. This year, views of over 160 toptier experts were collected.

This event is organized by the Expert Committee of the China General Chamber of Commerce (ECCGCC !"#$%&'()*+,-' ), a prestigious association comprising government officials, scholars, consultants, commentators, industry association representatives and top management of commercial enterprises in China.

Li & Fung Research Centre is proud to publish this report together with the Secretariat of the ECCGCC; by amalgamating the best intellectual talent in China, we believe this report will shed some light on the key development trends of China’s commercial sector.

About the Organizations

The China General Chamber of Commerce!"#$%&'

D#=(,.,! '(! BEEFG! /&.! %&'()! H.(.$)9! %&)->.$! #"! %#--.$0.! I%H%%J! '+! )! <=)+';:#3.$(-.(/!association endorsed by the State Council. The CGCC has around 70,000 members, encompassing enterprises from retail, distribution, services and tourism sectors, local commercial chambers, national professional associations, intermediary organizations and individuals.



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Commissioned by the Chinese Government, the CGCC consists of 14 committees, working on areas such as retailing, wholesaling, public relations, industry analyses, etc.; it also supervises 40 national associations, and over 30 newspapers and magazines published both inside and outside China.

The Expert Committee of the China General Chamber of Commerce !"#$%&'()*+,-'

The Expert Committee of the China General Chamber of Commerce (ECCGCC), a subdivision of the CGCC, comprises over 160 prominent experts from various government departments, research '(+/'/=/.+! )(,! =('3.$+'/'.+G! 9.),'(:! 0#$8#$)/'#(+G! 8$#".++'#()9! )++#0')/'#(+G! 0#(+=9/)(04! 2$-+! )(,!(.C+8)8.$!#"20.+G!C&'0&!'(09=,.!/&.!K'('+/$4!#"!%#--.$0.G!/&.!%&'(.+.!L0),.-4!#"!M#0')9!M0'.(0.+G!China Chain Store and Franchise Association, the Renmin University, the Capital University of Economics and Business, the Beijing Technology and Business University, etc.

The ECCGCC serves as a platform for the experts to exchange ideas on the development of commercial enterprises and the distribution sector.

Li & Fung Group./01

The Li & Fung Group is a Hong Kongbased multinational company with three distinct core businesses: sourcing, distribution, and retailing. Founded in Guangzhou in 1906, the Li & Fung Group achieved an annual turnover of around US$18.5 billion in 2010. Today, the Li & Fung Group operates in some 40 economies worldwide and employs over 37,000 people. One of its core competencies is “Supply Chain Management” (SCM).

Li & Fung Research Centre./23!4

Li & Fung Research Centre is the research institute of the Li & Fung Group. It serves as a knowledge bank on China's economy, industries, logistics and distribution sector, with its research scope covering the whole spectrum of the entire supply chain, from ideas, production, distribution, retailing to consumers. It also offers research analyses and consulting services to colleagues and clients.

The Centre has been actively promoting the application of SCM. The Centre published the book “The Orchestrator of Global Supply Chain Management (Second Edition)” in 2009, which is regarded as a very useful reference among businessmen and academia in China. The Centre also supported the launch of “100 Years of Li & Fung” and “Competing in a Flat World” in China.



Expert Panel Members

%)#!N'(/)(:G!O'$.0/#$!#"!P("#$-)/'#(!)(,!Q.C+!O'3'+'#(G!L,-'('+/$)/'3.!R"20.G!%&'()!H.(.$)9!%&)->.$!of Commerce345 !"#$%&'6789:;;<

Cao Lisheng, Deputy Secretary General, China General Chamber of Commerce3=> !"#$%&'?@A<

Chang Ka Mun, Managing Director, Li & Fung Development (China) Limited, Li & Fung Research CentreB)C ./DE (!" )FG7H ./01!2IJKLM

Chen Liping, Professor, Faculty of Management, Capital University of Economics and BusinessN=O PQLRSTUV#WXMYZ[ \]

Fan Shiyu, President, China Business Herald News^_` !"#abb<

Fu Longcheng, Deputy Secretary General, China General Chamber of Commercecde !"#$%&'?@A<

Hong Tao, Professor, Beijing Technology and Business Universityf g hi*#UVLRVj\]

Huang Guoxiong, Professor, School of Business, Remin University of Chinak"l !"mnUV#Vj\]

Li Gang, Deputy Department Head, Department of Market System Development, Ministry of Commerce of PRCo p #WqrstYuvH?;<

Liu Haifei, Director, China Research Institute of Business Economics, China General Chamber of Commercewxy !"#$%&'#$LR01!2Z[

Liu Jianhu, Vice Chairman, China General Chamber of Commercewuz !"#$%&'?'<

Pei Liang, Secretary General, China Chain Store and Franchise Association | !"~L'@A<



6

Song Ze, Research Fellow, Institute of Finance and Trade Economics, the Chinese Academy of Social Sciences !"b'VjS#$LR018Z[01-

7=! S')#<'G! T.+.)$0&.$G! O.8)$/-.(/! #"! U9.0/$#('0! %#--.$0.! )(,! P("#$-)/'V)/'#(G! K'('+/$4! #"!Commerce of the PRC #Wq#WH0-

Wang Aiguang, Research Associate, Beijing Vocational College of Finance and Commerce k hiS$Vj#$01?01-

Wang Xiang, Deputy Department Head, Department of Market Operation and Consumption Promotion, Ministry of Commerce of the PRCk #Wqrs4H?;<

Wu Shuang, Deputy Department Head, Department of Market Supervision, Ministry of Commerce of the PRC #WqrsH?;<

Zeng Lingtong, Vice President, International Business Management Group ¡ IBMG"¢#$XM£¤?K¥ Zhao Tao, Department of Circulation Industry Department, Ministry of Commerce of the PRC¦ g #Wq§¨$DEH



Chapter 2 Executive Summary

For many enterprises, the year 2011 was not an easy year; the weakening global economy has not only cast doubt over the growth prospects for the world economy, but also imposed huge pressure #(! /&.!%&'(.+.!.0#(#-46!K#$.#3.$G! '(W)/'#()$4!8$.++=$.G! /&.!)88$.0')/'#(!#"!T.(-'(>'! ):)'(+/! /&.!XM!,#99)$+!)(,!$'+'(:!0#+/+!#"!,#'(:!>=+'(.++.+! '(!%&'()!&)3.!0$.)/.,!+':('20)(/! '-8)0/!#(!%&'()*+!commercial sector.

Nevertheless, the government’s initiatives to boost domestic consumption as well as to promote a healthier business environment are bringing huge opportunities to commercial businesses. To stay ahead of /&.!-)$Y./G! .(/.$8$'+.+! )$.! ),3'+.,! /#! Y..8! /&.'$! 2(:.$+! #(! /&.! 8=9+.! #"!%&'()*+! 0&)(:'(:! 0#--.$0')9!landscape. Here is a brief summary of the Ten Highlights of Commercial Sector, 20112012:

1. Real retail sales of consumer goods will grow at a slower pace; stabilizing the economy by expanding domestic consumption becomes more challenging

The year 2012 is full of uncertainty. The Chinese economic growth is expected to further decline in 2012. Facing the European debt crisis, China's export growth is slowing; industrial production )(,!21.,!)++./!'(3.+/-.(/!:$#C/&!)$.!9'Y.94!/#!,.0.9.$)/.6!7&.!,./.$'#$)/'#(!#"!/&.!.18#$/!-)$Y./!as well as falling investment not only affect economic growth, but may also adversely affect employment and household income. All these factors may constrain domestic consumption. If there is no extension of consumption stimulus measures, it is expected that the total retail sales of consumer goods in real terms will fall to around 10% yearonyear in 2012.

2. Development Plan for Domestic Trade will set the framework and policy direction !"#$%&'()*+$,"-.+/'0$/#),.$+.0/"#$'($/&.$(.1/$23.$4.)#+

The longawaited Development Plan for China’s domestic trade during the 12th Fiveyear Plan period (201115) ("©STDEª«¬20112015®) is expected to be promulgated in early @AB@6!7&.!Z9)(!'+!%&'()*+!2$+/!()/'#()9!89)(!#(!,#-.+/'0!/$),.!)(,!+./+!/#!>.0#-.!/&.!>9=.8$'(/!for China’s domestic trade sector. The Plan will outline the policy framework for China’s domestic trade for the next five years, covering wholesale, retail, accommodation, catering and other service industries. Major themes of the Plan include expanding domestic demand, improving people’s livelihood and increasing household income, developing and modernizing the distribution sector, promoting the development of new retail formats and speeding up the development of the service sector.

3. As China’s exports shrink amid global economic uncertainties, more exportoriented enterprises are turning to domestic sales

On account of weakening export demand, many Chinese exporters have begun to focus on the country’s lucrative domestic market. However, selling in China is no easy task and is fraught



8

with obstacles, particularly for the traditional processing trade factories. With an aim to minimize risks and to lower transaction costs, our experts expect an increasing number of exportoriented enterprises will embark on domestic sales strategy with the help of wholesalers and distributors in China. Indeed, after years of development, a number of competitive regional distributors have emerged. But of course, there is further room for improvement in terms of logistics, data mining, 0)8'/)9!2()(0'(:G!)(,!>$)(,!-)():.-.(/!0)8)>'9'/'.+6!

4. Online retailing continues its stunning growth; growing calls for more stringent regulations, oversight and monitoring of China’s online retail market

Online retailing is an increasingly important sales channel in China. Our experts believe that China’s online retail market will continue its strong growth momentum; however, the downside of #(9'(.!$./)'9'(:!+&#=9,!(#/!>.!':(#$.,6!P++=.+!+=0&!)+!#$,.$!"=9299-.(/G!0#=(/.$".'/'(:G!'(."20'.(04!in distribution remain key concerns for the online retail market. But then, increasing efforts from the government to resolve the problems in online transaction and protect the interests of online shoppers will help boost the online retail market.

5. Building booms of commercial properties may lead to oversupply in the market

China’s commercial property market has continued to win huge attention from investors in 2011, amid series of tightening measures to cool down the residential property market. In the coming year, our experts expect that ongoing urbanization, the expansion of service industry as well as the emergence of metropolises will continue to attract property developers to invest in commercial properties. Yet, investment bubbles in commercial property sector should not be overlooked. Property developers and investors are advised to focus more on operational excellence and innovation.

56$ 7&.$8#"2/$-",.9$"!$+"-.$9)#:.;+0)9.$#./)'9.#+$'+$<=.+/'"(.,$>4$/&.$8=>9'0?$:#"@'(:$calls for the government to improve regulatory environment

Many largescale retailers in China have relied heavily on hefty slotting fees and other promotion and marketing fees from suppliers as their major source of income. This has aroused great attention among market players as well as the government. Industry experts believe more stringent measures shall be imposed by the Chinese government to promote a fairer competition environment for market players in the coming year.

7. Pressing need to address the issues of recruiting and retaining employees in retail industry

Shortage of employees will remain a major challenge for retail businesses in the coming year. M'(0.! /&.!<=)9'/4! #"! /&.!C#$Y"#$0.! '+! /&.!,.0'+'3.! ")0/#$! #"! 9#(:! /.$-!0#-8./'/'3.(.++!)(,!prosperity of the retail industry, concerted efforts from policymakers, industry associations,



retail enterprises and training institutes are therefore necessary to break the bottlenecks. Indeed, in face of labor shortage, some retailers have begun to seek remedies by cooperating with education institutes as well as recruitment agencies, building capabilities through internal /$)'('(:G!'-8$#3'(:!C#$Y'(:!.(3'$#(-.(/!)(,![#>!$.-=(.$)/'#(!8)0Y):.+G!.(&)(0'(:!."20'.(04!>4!optimizing internal management, etc.

8. Pilot tax reform program on logistics sector sets to strengthen the operating environment

The Chinese government has put forward a number of supportive measures in recent years to help improve the operating environment for the logistics sector. One area that we expect to see dramatic change is the tax regime. For instance, a pilot program to replace Business Tax (“BT”) with Valueadded Tax (“VAT”) was rolled out in Shanghai on 1 January 2012, focusing primarily on the transportation, logistics and modern services industries. The objectives are to reduce the double taxation caused by separate VAT and BT, and enable a fairer VAT input deduction system. Our experts believe that the proposed tax reform may reduce the heavy tax burden of logistics enterprises, and eventually leading to a better operating environment.

9. Increasing supply of governmentbacked wholesale and logistics facilities sets to lower distribution costs

In recent years, the Chinese government has stepped up its efforts to improve the distribution sector. A major initiative undertaken by the government is to provide more affordable distribution facilities and infrastructures such as warehouses, logistics centers, wholesale markets as well as information platforms for the public. It is believed that increasing participation of the government will help lower the distribution costs and improve people’s livelihood in China. Industry experts, however, urge the government should be selective when investing in or subsidizing the distribution facilities. Ownership rights according to the Property Law should be duly respected and considered.

10. Growing calls to lower business costs for China’s commercial and service sectors; more supportive measures are expected

Many commercial enterprises in China have been feeling the chill of rising business costs over the past few years. Undoubtedly, increasing market competition has driven up overhead costs such as rental and labor; there are some structural issues behind the high transaction costs facing China’s retail and distribution sector which are inherent in the country’s policy framework, such as fewer tax concessions and higher electricity tariffs. It is hoped that the government would propose comprehensive measures to help lower the costs of doing business during the upcoming National Work Conference on Distribution held by the State Council in early 2012.



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Chapter 3 Implications for Foreign Investors

The coming year is expected to be a challenging year for China as both the external and internal pressure is likely to persist through 2012. Fortunately, buoyed by relatively solid economic fundamentals and government’s initiatives to boost domestic consumption and create a better business environment, we believe the China market will continue to bring huge opportunities to commercial businesses. Businesses are advised to keep up vigilance against any possible external and internal shocks and gear up for a challenging time.

Here we offer a few points to note, particularly for foreign investors hoping to penetrate the lucrative China market.

Tougher retail environment

\! 7&.! 4.)$! @AB@! '+! 9##Y'(:! /#! >.!)(#/&.$! /#=:&! 4.)$! "#$! /&.! $./)'9! +.0/#$6!R(:#'(:! '("9)/'#()$4!pressure will continue to cast clouds over consumption sentiment, which may drag down real retail sales growth.

\! O.+8'/.!/&.!9'Y.9'&##,!/&)/!/&.!$./)'9!+)9.+!:$#C/&!'(!$.)9!/.$-+!C'99!.18.$'.(0.!,#C(C)$,!8$.++=$.!in the shortterm, we are positive towards the medium to longterm outlook of China’s retail sector. We believe the growth momentum will resume as 1) domestic consumption is an important driver of GDP under the National 12th FiveYear Plan; 2) China continues its effort to put forward urbanization and consumption upgrade; 3) household income is expected to increase steadily given the government’s determination to boost income of the lowincome households; and 4) CPI growth tends to slow down as the lowbase effect is going to fade out in 2012.

Increasing cost of doing business in China

\! P(,=+/$4!89)4.$+!C'99!0#(/'(=.!/#!.18.$'.(0.!-#=(/'(:!0#+/!8$.++=$.!'(!@AB@!)+!#8.$)/'#()9!0#+/+!are trending upward. Increasing market competition has driven up rental and labor costs, the two major components for commercial businesses. For instance, it is expected that average salary in China’s retail industry will increase by 10% to 20% in the coming year.

\! ]':&!/)1!>=$,.(!)(,!.10.++'3.!"..+!)9+#!8=+&!=8!/&.!0#+/!#"!,#'(:!>=+'(.++!'(!%&'()6!7&.$.!)$.!some structural issues behind the high transaction costs facing China’s retail and distribution sectors which are inherent in the country’s policy framework, such as having fewer tax concessions and paying higher electricity tariffs than the industrial sector.

\! U(/.$8$'+.+!-=+/!)9+#!>.!)C)$.!#"!#/&.$!2()(0')9!.18.(,'/=$.+!'(0=$$.,!'(!$=(('(:!>=+'(.++.+!'(!China. A typical example is the contribution to social insurance schemes. All enterprises in China must participate in social insurance schemes and pay social insurance premiums.



\! R(!/&.!#/&.$!&)(,G!9)>#$!+&#$/):.!$.-)'(+!)!Y.4!0&)99.(:.!'(!%&'()6!K#$.#3.$G!)8)$/!"$#-!)+Y'(:!"#$!&':&.$!8)4G!.-89#4..+!)$.!(#C!9##Y'(:!"#$!#/&.$!(#(;-#(./)$4!>.(.2/+!+=0&!)+!+&#$/.$!C#$Y!hours and better working environment; these further add to the burden of enterprises.

Keeping a pulse on new policies and regulations

\! P(! $.0.(/! 4.)$+G! /&.!%&'(.+.!:#3.$(-.(/! &)+!>..(!C#$Y'(:! 3.$4! &)$,! /#! 8$#-#/.! /&.!development of the service industry; this certainly is good news for commercial businesses. It is prudent for enterprises to pay attention to the latest policy and regulatory developments. Some latest or upcoming policies and regulations relevant to the commercial sector are as follows:

– It is widely anticipated that the Ministry of Commerce will unveil the Development Plan for Domestic Trade (20112015) ¯"©STDEª« (2011—2015 ) °by early 2012. It will >.!%&'()*+!2$+/!()/'#()9!89)(!#(!,#-.+/'0! /$),.6! P/! '+!.18.0/.,! /&)/!.""#$/+!C'99!>.!-),.! /#!further expand domestic demand as well as develop the distribution sector. How to facilitate the development of wholesale distribution sector and better the market environment will also be the focal points of the development plan.

– To better regulate the online retailing market and safeguard consumer interests, the Regulation on the Online Retail Market ¯±²³´XMµ¶° is expected to be released very soon. A better regulated ecommerce environment will facilitate the development of online retailing market in China.

– A pilot ValueAdded Tax (VAT) reform program has been rolled out in Shanghai. It shall have profound tax implications for logistics and transportation industry. Enterprises should closely monitor the change in tax policies.

Healthier business environment for domestic distribution

\! 7&.!%&'(.+.!:#3.$(-.(/! '+! ,./.$-'(.,! /#! 0$.)/.!)!-#$.! $.:=9)/.,!>=+'(.++!.(3'$#(-.(/6!Recognizing high distribution cost in China is unfavorable for the country to nurture a consumptiondriven economy, the government is taking steps to alleviate the problems by means of providing more affordable wholesale and logistics infrastructures and facilities. It shall help alleviate the cost burden of retail and distribution enterprises.

\! T./)'9.$+! $.94'(:!&.)3'94! #(! +9#//'(:! "..+!#$! '-8#+'(:!&)$+&! +)9.+! /.$-+!#(! +=889'.$+! )$.!detrimental to the health of China’s distribution sector. To address this issue, the government promulgated the Management Rules on Fair Transaction between Retailers and Suppliers¯³´#·¸#7O¹TXM6º°in 2006 and the !"#$%&'()*)+#,#*&'-#./*%.)0'12#.%3.)&%4*' 54"'Commercial Enterprises¯#S»$¼XM½¾ª¿° in 2008; it is anticipated that the Chinese authorities will roll out more stringent measures to restrain the unscrupulous practices of some retailers. It shall foster a better regulatory environment for domestic distribution.



12

Enhancing core competencies is the key to success

\! %&'(.+.!0#(+=-.$+!)$.!>.0#-'(:! '(0$.)+'(:94!,'+0.$('(:!)(,!.18.0/!>.//.$!0&#'0.+!)(,!-#$.!=('<=.!-.$0&)(,'+.!#"".$'(:+6!^'/&!/&.!$)8',!:$#C/&!#"!3)$'#=+!$./)'9!"#$-)/+!+=0&!)+!8$#".++'#()9!stores, discount outlets and online retailing platforms, suppliers and brand owners have more choices for product distribution. Retail operators are advised to focus more on operational excellence and innovation. We believe differentiated positioning and continuous improvement in products and services are a must for enterprises to stay ahead of competition. Moreover, .(/.$8$'+.+!+&#=9,!)9+#!'-8$#3.!+=8894!0&)'(!."20'.(04!/#!)99.3')/.!/&.!'(0$.)+'(:!0#+/!>=$,.(6!

Riding the Internet boom in China

\! ^'/&!/&.!$'+'(:!8#8=9)$'/4!#"!#(9'(.!+&#88'(:G!#(9'(.!/$),'(:!89)/"#$-!'+!)(!'(0$.)+'(:94!'-8#$/)(/!sales channel in China. Indeed, more and more traditional retailers are resorting to online retailing platforms to reach out to customers. Having said that, selling products online can be a challenge. Although the Internet offers tremendous opportunities to businesses and is the fastestgrowing sales channel, the problems of counterfeiting and online frauds are deeply rooted in this redhot sales channel. With increasing government efforts to regulate the online market, we are positive on the growth prospect of online retailing in China.

\! U(/.$8$'+.+!)$.!),3'+.,!/#!=/'9'V.!/&.!#(9'(.!89)/"#$-!/#!.18)(,!/&.'$!-)$Y./!$.)0&!)(,!'(0$.)+.!brand awareness in China. However, they should do thorough planning before starting their #(9'(.!>=+'(.++.+6!M8.0')9!)//.(/'#(!-=+/!>.!8)',!/#!8$'0'(:!+/$)/.:4!/#!-)'(/)'(!#(9'(.!)(,!#"W'(.!consistency in order to avoid online channels cannibalizing sales of physical stores, as well as 8#/.(/')9!0#(W'0/!#"!'(/.$.+/+!C'/&!.1'+/'(:!,'+/$'>=/#$+!)(,!"$)(0&'+..+6!U(/.$8$'+.+!0#=9,!0#(+',.$!launching exclusive product offerings for online sales or having an identical pricing policy for the +)-.!#(9'(.!)(,!#"W'(.!'/.-+6!

Leveraging on exportoriented enterprises

\! L+! /&.!8=$0&)+'(:! 8#C.$! #"!%&'(.+.! 0#(+=-.$+! '(0$.)+.+G! )! :$#C'(:!(=->.$! #"! .18#$/;oriented enterprises are beginning to target domestic sales. But very often, they face a number of obstacles when launching domestic sales such as high costs, lack of knowhow and little investment in branding. Wholesale distribution enterprises, with their wide networks of distribution channels, can play a crucial role in helping the exportoriented enterprises to channel their products to end consumers. On the other hand, retailers may also consider leveraging on exportoriented enterprises to develop private labels in China. Businesses should not overlook these unexplored, but vast potentials.



Chapter 4 The Ten Highlights of China’s Commercial Sector, 201112

1. Real retail sales of consumer goods will grow at a slower pace; stabilizing the economy by expanding domestic consumption becomes more challenging

China’s economic growth moderated in 2011 compared to 2010, given the government’s efforts '(! )00.9.$)/'(:! .0#(#-'0! $.+/$=0/=$'(:G! 0#(/$#99'(:! '(W)/'#(! )(,! -#,.$)/'(:! /&.! 8$#8.$/4! -)$Y./6!According to a forecast by Asian Development Bank in December 2011, China's annual GDP growth rate of 2011 will slow to 9.3% yearonyear (yoy) from 10.3% in 2010. Looking ahead, it is expected that the Chinese economic growth will further decline in 2012, due to the weakening foreign and domestic demand. Domestic consumption will remain strong, but at a lower growth rate compared with that of 2011.

Growth of nominal and real retail sales decelerated amid the weakening economy

According to the National Bureau of Statistics (NBS), total retail sales of consumer goods grew nominally by 17.0% yoy to reach 16,348.6 billion yuan between January November 2011, the growth was lowered by 1.4 percentage points (ppt) than that of 2010; real growth was 11.4% yoy, the lowest level since 2005.

By mode of sales, the retail sales of commodities reached 14,493.9 billion yuan between January – November 2011, up nominally by 17.1% yoy; the catering industry posted sales growth of 16.7% yoy in nominal terms to reach 1,854.7 billion yuan.

According to China National Commercial Information Centre (CNCIC)1, the monthly growth of retail sales of the top 100 retail enterprises declined from 27.82% in September to 18.27% in October and 15.98% in November. The growth was on a downward trend towards the end of 2011.

China’s CPI growth moderated after reaching the peak level in July 2011

Driven by mounting food and housing prices, yoy growth rate of China’s consumer price index (CPI) stayed high during 2011. It peaked at 6.5% yoy in July, the highest in thirty seven months since June 2008. Although CPI eased in October and November, the accumulated CPI growth from JanuaryNovember 2011 stayed high at 5.5% yoy. It is expected that the yoy CPI growth in 2011 would be the highest in three years.

1 Source: http://www.cncic.org/index.php?option=com_content&task=view&id=29285&Itemid=14



14

Gradual withdrawal of the government subsidies affected the sales of selected categories

The retail sales of commodities of enterprises above designated size2 grew by 22.8% yoy to reach 7,554.8 billion yuan in January – November 2011.

The gradual withdrawal of the government subsidies on car purchases and the government measures to limit new car registrations in some cities in 2011 adversely affected the sales of “automobiles” in the short term. Some cities such as Beijing placed restrictions on the number of newly purchased 0)$+! '(! /&.!0'/4! /#!0#8.!C'/&! /$)"20!0#(:.+/'#(6! P(!N)(=)$4! ;!Q#3.->.$!@ABBG!)-#(:! /&.! $./)'9! +)9.+!of commodities of enterprises above designated size, the growth of sales of “automobiles” slowed to 15.2% yoy, down from 34.5% yoy in the same period last year.

Meanwhile, housingrelated items also saw slower sales growth, which was largely attributable to the government’s efforts to cool down the overheated housing market. Growth of sales of “furniture” and _&#-.!)889')(0.+!)(,!3',.#!.<='8-.(/+`!'(!N)(=)$4!a!Q#3.->.$!@ABB!C.$.!bB6Ec!4#4!Id65!88/!9#C.$!than that of the same period in 2010) and 20.3% yoy (6.6 ppt lower than that of the same period in 2010) respectively.

Sales growth of gold, silver and jewelry slowed down

P(! /&.!2$+/!&)9"!#"!@ABBG!+)9.+!#"! _:#9,G!+'93.$G!)(,! [.C.9$4`! $.:'+/.$.,! /&.!+/$#(:.+/!:$#C/&!#"!FE65c!yoy among various commodities; it was mainly driven by the increase of international gold prices and ,#-.+/'0!%ZP6!D$#-!M.8/.->.$!#(C)$,+G! '(/.$()/'#()9!:#9,!8$'0.+!,.0$.)+.,!)(,!,#-.+/'0! '(W)/'#(!eased, sales growth of “gold, silver, and jewelry” slowed to 32.3% yoy in October and 16.2% yoy in November, recording the slowest monthly growth in 2011.

Rural retail sales grew at a faster pace

In January – November 2011, the urban retail sales totaled 14,158.9 billion yuan, up nominally by 17.1% yoy. Meanwhile, rural retail sales amounted to 2,189.7 billion yuan, up by 16.6% yoy. Given the more rapid growth of per capita disposable income of rural households than urban households, the difference between the growth rates of urban and rural retail sales reduced from 2.7 ppt between N)(=)$4!a!Q#3.->.$!'(!@ABA!/#!A6d!88/!'(!/&.!+)-.!8.$'#,!'(!@ABB6!P(!/&.!2$+/!/&$..!<=)$/.$+!#"!@ABBG!per capita cash income of rural households recorded doubledigit real growth of 13.6%, boding well for rural consumption. In comparison, the per capita disposable income of urban households amounted to B5GbAB!4=)(!'(!/&.!2$+/!/&$..!<=)$/.$+!#"!@ABBG!:$#C'(:!)/!)!+9#C.$!8)0.!#"!e6fc!4#46!

2 Enterprises above designated size refer to enterprises with annual sales of 5 million yuan or above and with an employment of or over 60.



The Chinese economic growth is expected to slow further

As concluded in the Central Economic Work Conference in late 2011, Chinese policymakers would -)'(/)'(!g)!8$#)0/'3.!2+0)9!8#9'04!)(,!)!8$=,.(/!-#(./)$4!8#9'04g!'(!@AB@6!7&.4!)9+#!8$#-'+.,!:$#C/&G!+/)>'9'/4!)(,!'(W)/'#(!/#!>.!=(,.$!0#(/$#96!

The year 2012, however, is still full of uncertainty. The Chinese economic growth is expected to further decline in 2012. Facing the European debt crisis, China's export growth is slowing; industrial 8$#,=0/'#(!)(,!21.,!)++./!'(3.+/-.(/!:$#C/&!)$.!9'Y.94!/#!,.0.9.$)/.6!7&.!,./.$'#$)/'#(!#"!/&.!.18#$/!market as well as falling investment not only affect economic growth, but may also adversely affect employment and household income; all these may constrain domestic consumption. It is expected that the real growth rate of total retail sales of consumer goods will be decelerated to around 10% yoy in 2012.



16

2. Development Plan for Domestic Trade will set the framework and policy direction !"#$%&'()*+$,"-.+/'0$/#),.$+.0/"#$'($/&.$(.1/$23.$4.)#+

The longawaited Development Plan for China’s domestic trade during the 12th Fiveyear Plan period (201115) (“the Plan”) ("©STDEª«¬20112015®) is being formulated and is expected to >.!8$#-=9:)/.,! '(!.)$94!@AB@6!7&.!Z9)(! '+!%&'()*+!2$+/!()/'#()9!89)(!#(!,#-.+/'0! /$),.!)(,!+./+! /#!become the blueprint for China’s domestic trade sector. The Plan will outline the policy framework for %&'()*+! ,#-.+/'0! /$),.! "#$! /&.! (.1/! 23.! 4.)$+G! 0#3.$'(:!C&#9.+)9.G! $./)'9G! )00#--#,)/'#(G! 0)/.$'(:!and other service industries. More than ten ministries and departments have been involved in formulating the Plan.

Policy direction for China’s domestic trade in 12th FYP period

R(.! #"! /&.! Y.4! 8#9'04! #>[.0/'3.+! #"! /&.!%&'(.+.! :#3.$(-.(/! '(! /&.! (.1/! 23.! 4.)$+! '+! /#! )00.9.$)/.!the transformation of the country’s economic growth model from one that is exportoriented and investmentled, to one that is consumptiondriven. Boosting domestic consumption remains high on the government agenda. There is also a very clear shift in the government’s focus from the speed to /&.!<=)9'/4!#"!:$#C/&G!)(,!"$#-!.0#(#-'0!:$#C/&!/#!+#0')9!C.9")$.!#3.$! /&.!(.1/!23.!4.)$+6!L99! /&.+.!have enormous implications on the formulation of the policy framework for China’s domestic trade sector.

Our experts expect the following areas to be the focal points of the Plan:

\! U18)(,'(:!,#-.+/'0! ,.-)(,6!7&.!:#3.$(-.(/!C'99! 0#(/'(=.! /#! >##+/! ,#-.+/'0! ,.-)(,G!especially household consumption. It is hoped that the economic growth would be supported by all three economic drivers i.e. exports, investment and consumption, in a coordinated manner.

\! P-8$#3'(:!8.#89.*+!9'3.9'&##,!)(,!'(0$.)+'(:!&#=+.&#9,!'(0#-.6!h##+/'(:!.-89#4-.(/!'+!#(.!#"!the top priorities. The target is to create more than 45 million jobs in urban areas over the next 23.!4.)$+6!^'/&!/&.!:#3.$(-.(/*+!.""#$/+!/#!'(0$.)+.!-'('-=-!C):.!)0$#++!/&.!()/'#(G!)(,!$)'+.!the price of agricultural products, as well as its continuous efforts to push forward urbanization, income growth of rural and lowincome urban residents are expected to increase further in the (.1/!23.!4.)$+6!7&.4!C'99!>.!/&.!>$.)Y/&$#=:&!8#'(/+!"#$!,$'3'(:!,#-.+/'0!0#(+=-8/'#(6!

\! O.3.9#8'(:!)(,!-#,.$('V'(:! /&.!,'+/$'>=/'#(! +.0/#$6!7&.!:#3.$(-.(/!C'99! .+/)>9'+&!)! 9#(:;/.$-!mechanism to modernize the distribution sector i.e. to improve the distribution network and distribution infrastructure in rural areas, as well as small and mediumsized cities.

\! Z$#-#/'(:! /&.!,.3.9#8-.(/!#"! (.C! $./)'9! "#$-)/+6!7&.! $'+.!#"! .;0#--.$0.!&)+! 9.,! /#! /&.!emergence of new retail formats and distribution channels such as online shopping, mobile shopping, online payment, “Internet of Things“ and elogistics. This will provide an impetus to boosting domestic consumption.



\! M8..,'(:!=8! /&.!,.3.9#8-.(/! #"! /&.! +.$3'0.! +.0/#$6!7&.!Z9)(! '+! .18.0/.,! /#! =(3.'9! )! (=->.$!of supportive measures to foster the development of the service industry, for instance, the =('20)/'#(!#"! =/'9'/'.+! 8$'0.+! "#$! +.$3'0.!8$#3',.$+!)(,! '(,=+/$'.+G! '(0$.)+'(:! 9)(,! +=8894! "#$! /&.!+.$3'0.! '(,=+/$'.+G! 8$#3','(:!-#$.! 2()(0'(:! 0&)((.9+G! #"".$'(:! +=88#$/+! "#$! 0)8'/)9! "=(,'(:!)(,!share listing, etc.

P/! '+! .18.0/.,! /&)/! '"! /&.! )>#3.! '('/')/'3.+! )$.! ."20'.(/94! '-89.-.(/.,G! %&'()*+! /#/)9! $./)'9! +)9.+! C'99!double that of 2010 to reach 32 trillion yuan by 2015, with an annual growth rate of 15%, and that the number of persons employed in China’s domestic trade sector will reach 130 million by 2015, of which 100 million are urbanites.

Growing calls for the government to hasten implementation of the Plan

Given the broad scope and complexity of the Plan, our experts urge the government to put more emphasis on the implementation of the blueprint. To ensure the objectives are achieved, government ministries and departments are advised to closely monitor the implementation of the policies related /#! /&.'$!2.9,+!)(,!.3)9=)/.! /&.! '-89.-.(/)/'#(!8$#:$.++! "$#-! /'-.! /#! /'-.?! /&.4!+&#=9,!)9+#!8$#3',.!09)$'20)/'#(! #"! /&.! 8#9'0'.+! C&.(! /&.! 8=>9'0! .18$.++.+! 0#(0.$(! #(! /&.-6! D=$/&.$-#$.G! 09#+.! '(/.$;governmental coordination is also critical to the successful roll out of the Plan.



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3. As China’s exports shrink amid global economic uncertainties, more exportoriented enterprises are turning to domestic sales

China’s export growth is facing strong headwinds amid global economic uncertainties. Some leading advanced economies are struggling hard the deepening debt crisis in Europe, stagnation in the X('/.,! M/)/.+G! )(,! ,.9)4.,! $.0#3.$4! '(! N)8)(! "#99#C'(:! /&.!-)++'3.! .)$/&<=)Y.! /&)/! /##Y! 89)0.! '(!March 2011 and the resulting nuclear power catastrophe. All these not only cast clouds over the overall economic growth of the world, but also impose huge pressure on China’s export.

Industry experts believe that the global economy is yet to stabilize in the coming year. On account of weakening export demand, many Chinese exporters have begun to focus on the country’s lucrative domestic market. However, selling in China is no easy task and is fraught with obstacles, particularly for the traditional processing trade factories.

Major obstacles faced by exportoriented enterprises when launching domestic sales

1. Enterprises must transform their registrations into FIEs; procedures are long and costly

To sell in the domestic market, traditional processing trade factories (TFPs) have to transform their registrations into foreigninvested enterprises (FIEs) and temporarily stop their production for auditing by the Customs. Production stoppage can take 9 to 12 months, which will undoubtedly .1.$/!&=:.!8$.++=$.+!#(!/&.!0)+&!W#C!#"!-)(46!D=$/&.$-#$.G!/&.!/$)(+"#$-)/'#(!"$#-!8$#0.++'(:!trade to foreigninvested enterprises involves the work of more than 10 government departments; the procedures are even more complicated if enterprises want to sell their products to different provinces in China.

Transformation into FIEs can also incur substantial tax repayments. Factories engaging in export processing are exempt from paying tariffs on imported components and machinery. However, if they plan to sell finished products domestically, they must obtain prior approval from the respective provincial governments, and repay the related tariffs and valueadded tax (VAT).

A6$ B'!!.#.(/$8#",=0/$0.#/'20)/'"($+/)(,)#,+$

! D#$!0.$/)'(!/48.+!#"!8$#,=0/+G!%&'()!&)+!'/+!+8.0'20!+)"./4!)(,!<=)9'/4!0.$/'20)/'#(+G!C&'0&!-)4!>.!,'"".$.(/!"$#-!+#-.!#"!/&.!'(/.$()/'#()994!)00.8/.,!#(.+6!%&'()!%#-8=9+#$4!%.$/'20)/'#(!I%%%J!'+!a case in point. CCC prohibits certain types of products from selling or importing without bearing the CCC mark. Even if the madetoexports by TFPs have already obtained international safety )(,!<=)9'/4! 0.$/'20)/'#(+G! /&.+.!8$#,=0/+!-)4!&)3.! /#! >.! $.;.1)-'(.,!>."#$.! +.99'(:! '(!%&'()G!adding to the compliance costs for enterprises.



3. Risks of payment delays and property rights infringements

After decades of economic reforms, there is a dramatic shift in power from sellers to buyers in China. Retailers with strong distribution networks in particular have much stronger power in the supply chain. Many retailers have passed on their costs to suppliers and levied various charges on suppliers under different names, such as entrance fees, product listing fees, festival fees, and promotion and advertising fees. There is often tension between retailers and suppliers.

Besides, the credit system in China is relatively immature. The notorious yet common practice of China’s retailers delaying payments to suppliers has deterred many from engaging in domestic sales. Today, payment period for China’s domestic sales can be up to 2 to 3 months. There are high incidences of payment defaults as well, adding to the risks of suppliers. On the contrary, /&.! /$)(+)0/'#(! 0#+/+! )(,! 2()(0')9! $'+Y+!)$.! 0#(+',.$.,!-=0&! 9#C.$! .(:):'(:! '(! "#$.':(! /$),.!activities with payments better secured by Letter of Credits and different exports insurance.

Another obstacle is weak enforcement and protection of intellectual property rights. Property rights infringements and counterfeits in China are common concerns.

4. Huge differences between domestic and foreign trade engagements

Indeed, there are huge differences between domestic and foreign trade engagements in terms of method of payment, mode of operation, business registration and the applicable regulations, etc., deterring enterprises from engaging in domestic sales. Exhibit 1 summarizes the major differences. Foreign orders are typically larger in size with product specifications provided by clients. Payments are better secured and TFPs are exempt from paying VAT and tariffs.



20

Exhibit 1: Engaging in domestic trade vs. foreign trade

Domestic Trade Foreign TradeOrder volume Smaller order volume, but orders are Larger order volume.! :.(.$)994!89)0.,!'(!)!-#$.!"$.<=.(/! manner.Method of payment Case by case for each manufacturer. Use the Letter of Credit, which Usually late payments by the clients. is internationally accepted. Buyers usually pay deposit in advance and pay in full upon delivery of products.Operation! h=4.$+!$.<='$.!/&.!-)(=")0/=$.$+!/#!! h=4.$+!8$#3',.!/&.! 8$#,=0.!/&.!8$#,=0/+!2$+/!)(,!/&.(!! -)(=")0/=$.$+!C'/&!,.+':(+!! determine the order volume after and other technical ! .1)-'('(:!/&.!8$#,=0/+6!P/!'(0$.)+.+!! $.<='$.-.(/+!C&.(!89)0'(:! risks such as excessive inventory to orders. the manufacturers. Marketing & aftersale ! h=4.$+!$.<='$.!/&.!-)(=")0/=$.$+!/#!! K)(=")0/=$.$+!)$.!(#/!'(3#93.,!services work together for better sales in such aspects as marketing performance by asking them to take and aftersale services. part in the promotion and advertising, ! C&'0&!'(3#93.+!-)(8#C.$!)(,!2()(0')9! resources.Source: Compiled by Li & Fung Research Centre

Twinpronged strategy: a common approach adopted by Chinese exporters

With ongoing urbanization, burgeoning middleclass as well as further development of secondand thirdtier cities and the rural market, China’s consumer market should continue to be one of the fastest growing in the world. This explains why increasing efforts are being made by Chinese exporters to tap the home market despite the abovementioned obstacles. Instead of relying solely on export markets, more and more manufacturing enterprises now employ a twinpronged strategy or socalled “walking on two legs”, by engaging in both domestic and foreign trade sectors.

Major strategies deployed by exportoriented manufacturers

Moving upstream

Over a long period of time, processing trade enterprises in China engaging in assembling production have put little emphasis on product research, design as well as brand development. Without much market recognition of their products, tapping the already crowded domestic retail scene is a



huge challenge. To overcome their shortcomings, some exportoriented factories have increased investments in areas of design and brand building to facilitate product sales.

Forming sales alliances

Most of the smalland mediumsized enterprises in China have limited resources; some of them have joined hands with one another to cultivate the domestic market through the sharing of costs such as transportation, promotion and marketing costs. By collaborating efforts such as forming sales alliances, they could achieve economy of scale and increase their bargaining power. For instance, 23.!.18#$/;#$'.(/.,!&#-.!"=$('+&'(:!")0/#$'.+!'(!D#+&)(!&)3.!>='9/!)!$./)'9!#=/9./!=(,.$!)!=('2.,!$./)'9!brand “Joyhere”(ÀÁÀÂ ) in an attempt to expand domestic sales.

Leveraging on industry associations in China

Some enterprises are leveraging on industry associations in China to expand domestic sales. For instance, some Taiwanese export enterprises in Dongguan have leveraged on industry associations in China and established a brand new domestic sales platform called TMark, with an aim to promote Taiwanese brands and avoid cumbersome slotting fees levied by big retailers. Another example is the establishment of the Pearl River Delta Hong Kong Products Sales Centre (ÃÄÅÆ»ÇÈKLÉ!2 ) in Shenzhen. The sales centre exhibits the products made by Hong Konginvested factories in Pearl River Delta and helps sell the products to modern format retailers such as shopping malls, supermarkets and shopping centers through centralized arrangements.

Using online trading platforms to reduce distribution costs

To reduce distribution costs, some exportoriented factories have engaged in direct sales through online trading platforms. Riding on the online market boom, a number of factories have rolled out their B2C websites to reach customers more directly. For instance, madetoexport products have become one of the popular product categories of Taobao.com (ÊË± ), which has over 80% of total market share in China’s online retailing market; B2B platform operator Alibaba has also established a dedicated storefront for listing “madeinDongguan” products in a bid to promote the use of online platform to expand domestic sales.

Increasing efforts by the government to facilitate domestic sales

To facilitate factories selling domestically, the Chinese government has introduced a series of measures in recent years. For instance, Guangdong, which is the home for many processing factories, has stepped up efforts to promote domestic sales. Measures include the promotion of “selling Guangdong products nationwide” (ÌÍÎ" ). The Dongguan government has rolled out a onestop application platform to help factories get over the cumbersome government procedures. Bonded logistics centers have also been set up to help lower the logistics cost for enterprises. Hong Kong government has set up a HKD 1 billion fund to support factories to tap Chinese market.



22

Besides, the Chinese government has introduced a “Notice on Implementing Pilot Works on Upgrade and Transformation of Processing Trade” (ÏEÐ*STÑÒÓÔÕÖ*+×¨Ø ) in November 2010, choosing Dongguan and Suzhou as the pilot cities to readjust and upgrade its industrial structure in /&.!0#-'(:!4.)$+6!O#-.+/'0!+)9.+!'(!/&.+.!8'9#/!0'/'.+!&)3.!>..(!:$#C'(:!:$),=)9946!D#$!/&.!2$+/!+.3.(!months of 2011, domestic sales value in Dongguan’s processing trade factories accounted for 50% of its total export sales; domestic sales in Suzhou’s foreigninvested enterprises increased by 22% yoy which is 1.8 percentage points higher than the export growth.

Tapping the domestic market with the help of wholesalers and distributors

Going forward, our experts expect an increasing number of foreign brand owners and exportoriented enterprises will embark on domestic sales strategy with the help of wholesalers and distributors in China, with an aim to minimize risks and to lower transaction costs. Indeed, after years of development, a number of competitive regional distributors have emerged. But of course, /&.$.! '+! "=$/&.$! $##-!"#$! '-8$#3.-.(/! '(! /.$-+!#"! 9#:'+/'0+G!,)/)!-'('(:G!0)8'/)9!2()(0'(:G!)(,!>$)(,!management capabilities.



4. Online retailing continues its stunning growth; growing calls for more stringent regulations, oversight and monitoring of China’s online retail market

Online retailing1 is an increasingly important sales channel in China, especially among young consumers. The growth of online retailing was the fastest among all retail formats in China in 2011. According to iResearch, the transaction value of China’s online retail market was up by 74% yearon4.)$!I4#4J!/#!$.)0&!beA6e!>'99'#(!4=)(!'(!/&.!2$+/!&)9"!#"!@ABB2. It is expected to reach 760 billion yuan in 2011, accounting for 4.2% of the total retail sales of consumer goods3.

Looking forward, our experts believe that China’s online retail market will continue its strong growth momentum; however, the downside of online retailing should not be overlooked. Issues such as order "=9299-.(/G!0#=(/.$".'/'(:G! '(."20'.(04! '(!,'+/$'>=/'#(! $.-)'(!Y.4!0#(0.$(+! "#$! /&.!#(9'(.! $./)'9!-)$Y./6!But then, increasing efforts from the government to resolve the problems in online transaction and protect the interests of online shoppers will help boost the online retail market.

Major highlights of China’s online retail market in 2011

1. Slow development of brickandclick model

According to CNZZ, there were 12,400 online retail websites in China by the end of June 20114. Traditional retailers in China begin to respond to the fastgrowing online retail market, but the pace is relatively slow. China Chain Store and Franchise Association (CCFA) reported that among the top 100 retail chain operators in China, only 52 enterprises have launched their online portals in 20105. This shows that the development of the brickandclick model in China remains relatively slow. Many traditional retailers are not familiar with selling online, posing extra challenges for them to reach breakeven for their online businesses. For example, Metersbonwe announced in October 2011 that it would stop operating its own ecommerce business; instead, it would entrust Shanghai Banggo Information Technology (Banggo) to sell its products online under the domain name Banggo.com. 7$),'/'#()9!$./)'9.$+!)9+#!&)3.!/#!0#(+',.$!0#(W'0/+!>./C..(!#(9'(.!)(,!#"W'(.!+/#$.!'(!/.$-+!#"!3)$'./4!of products and prices. They have to pay extra attention to pricing strategy to maintain online and #"W'(.! 0#(+'+/.(04! '(! #$,.$! /#! )3#',! #(9'(.! 0&)((.9+! 0)(('>)9'V'(:! +)9.+! #"! /&.'$! #"W'(.! +/#$.+! )(,!8#/.(/')9!0#(W'0/!#"!'(/.$.+/+!C'/&!.1'+/'(:!,'+/$'>=/#$+!)(,!"$)(0&'+..+6

1 According to iResearch, online retailing refers to businesses conducted consumertoconsumer (C2C) and businesstoconsumer (B2C) online businesses.

2 Source: China Online Shopping Research Report 20102011, April 2011, iResearch Consulting Group; http://www.iresearch.com.cn/Report/1541.html

b! M#=$0.i!&//8ijj'6)9'$.+.)$0&60#-j29.j@ABBB@ABj@ABBB@ABBdAEB568,"!4 Source: http://soft.ccw.com.cn/news/htm2011/20110630_935369.shtml5 Source: http://www.ccfa.org.cn/viewArticle.do?method=viewArticle&id=ff8080812ffb71a30131dfb36bd10a42



24

2. Online retailers shifted from competing on price to competing through customer service; moneyback guarantee is becoming more common

Online retailers are shifting from competing on price to competing through customer service. Money>)0Y!:=)$)(/..!'+!)!0#--#(!/##9!"#$!#(9'(.!$./)'9.$+!/#!C'(!/&.!0#(2,.(0.!#"!0#(+=-.$+6!D#$!.1)-89.G!k)(09*+! bA;,)4!-#(.4;>)0Y!:=)$)(/..!)99#C+! 0#(+=-.$+! /#! :./! "=99! $."=(,+! '"! /&.4!)$.!(#/! +)/'+2.,!with the products for any reasons. Other B2C portals such as Taobao Mall, 360 Buy, Dangdang and group buying websites such as Lashou (ÙÚ± ), Aibang (Û± ), Meituan (Ü¤± ) also offer a 7day moneyback guarantee program, promising refunds of products for whatever reasons within seven days of purchases. Although moneyback guarantee may increase the operation cost of online retailers, more customers can be drawn.

C6$ D#"@'(:$(=->.#+$"!$#.+',.(/')9$"(9'(.$#./)'9$"8.#)/"#+$+..E'(:$/"$:"$"!F'(.

A number of online websites serving residential communities have evolved in recent years. These website operators usually offer food and daily necessities; some even provide home delivery services within certain districts. Selected examples included http://www.ejr.cc/ (e)m±²Ýr ) and http://www.somepu.com/ (Þß± ) in Shenzhen.

7#,)4G!-)(4!#"!/&.+.!$.+',.(/')9!#(9'(.!$./)'9!#8.$)/#$+!)$.!)0/'3.94!:#'(:!#"W'(.!/#!)//$)0/!0#(+=-.$+!who are not comfortable with online shopping. Customers can get the products they ordered in the #"W'(.!+/#$.+6!7&.!+/#$.+!)9+#!8$#3',.!#/&.$!3)9=.;),,.,!+.$3'0.+!+=0&!)+!)99#C'(:!0=+/#-.$+!/#!8)4!their electricity and telephone bills, offering laundry services, etc. For example, http://shop.r114.com.cn ([àáâ ), which serves the Beijing Daxing district (hiUãä JG!&)+!9)=(0&.,!-#$.!/&)(!BA!#"W'(.!stores in Daxing district.

4. International players accelerated investment in online operation in China

China’s online market is dominated by domestic companies. Chinese companies have definite advantages in language, culture and local knowledge, giving them an edge in areas such as content selection, interface design, and sales and marketing, etc. Foreign companies have faced many challenges adapting to the China market. Many have chosen to increase their share in the China -)$Y./! >4! )0<='$'(:! ,#-.+/'0! #(9'(.! 89)4.$+6! D#$! .1)-89.G!L-)V#(!)0<='$.,! N#4#60#-!)+!.)$94! )+!'(! @AAF6!^)9;K)$/G! #(! /&.! #/&.$! &)(,G! )0<='$.,! )! -'(#$'/4! +/)Y.! '(! l'&)#,')(! IBåæ ) http://www.yihaodian.com in May 2011, hoping to reduce the risk of selfoperation and penetrate the market <='0Y946



5. Group buying market has started to cool down since the second half of 2011

Although group buying market has been growing exponentially in China in recent years, group buying website operators also face numerous challenges. According to a report on group buying market in China by eTao (çÊ± )1, the shoppingrelated search engine of Taobao, the number of group buying websites in China peaked at 5,700 in August 2011; however, around 2,000 of them have exited the market as of November 2011. Indeed, according to eTao, the top 22 players in the market accounted for 96% of the market share in November 2011. The market concentration is very high that it is expected that the market will go into a stage of consolidation.

According to Analysts International, the transaction volume, user activities and number of orders of group buying websites have decreased since July 2011. Market being too concentrated, low differentiation, poor customer services and low credibility are some of the major problems in China’s group buying market. Many of the group buying website operators are lossmaking. For example, Lashou, one of the most popular group buying websites in China, recorded a loss of 360 million yuan '(!/&.!2$+/!&)9"!#"!@ABB6!D#$!-)(4!+-)99.$!89)4.$+G!2()(0'(:!'+!'(0$.)+'(:94!,'"20=9/!)(,!-)(4!#"!/&.-!)$.!)0<='$.,!>4!9)$:.$!89)4.$+6

6. Counterfeiting and online frauds remain the major problems of online shopping in China

Counterfeiting is always one of the biggest problems encountered by the online retail market in China. D=.99.,!>4!/&.!8#8=9)$'/4!#"!#(9'(.!+&#88'(:G!0#=(/.$".'/'(:!'+!(#C!<='0Y94!.18)(,'(:!'(/#!-)(4!#/&.$!8$#,=0/! 0)/.:#$'.+! >.4#(,! 9=1=$4! 8$#,=0/+6! ! L(,! ")Y.,! 8$#,=0/+! )9+#! W#0Y! /#! -)(4! .;0#--.$0.!C.>+'/.+6!D#$! '(+/)(0.G!L9'>)>)G!%&'()*+! 9.),'(:!.;0#--.$0.!+.$3'0.+!8$#3',.$G! ',.(/'2.,! "$)=,=9.(/!transactions involving 2,326 suppliers in February 2011.

In recent years, the government has taken steps to address many problems facing China’s online retail sector including counterfeiting and online frauds. For example, in April 2011, the Government announced the Notice for Combating Intellectual Property Infringement and Counterfeits in Online Shopping (èé4çêë4±ìíîïðñòóôØ_Çõö´÷øùú#Èû×¨Ø ). Online shopping platform operators should take responsibility to monitor if the goods sold online infringe intellectual property rights and counterfeits. According to a spokesman for the Ministry of Commerce, China plans to promulgate the Regulation on the Online Retail Market (±²³´XMµ¶ )2, aiming to further regulate thirdparty transaction platforms.

We believe that better regulation would facilitate the development of the online retail market in China.

1 Source: http://www.wuzhongzx.com/ebusiness/ebusiness_article118_78010.html2 Source: http://news.xinhuanet.com/fortune/201112/20/c_111259729.htm



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5. Building booms of commercial properties may lead to oversupply in the market

China’s commercial property market has continued to win huge attention from investors in 2011, amid +.$'.+!#"!/':&/.('(:!-.)+=$.+!/#!0##9!,#C(!/&.!$.+',.(/')9!8$#8.$/4!-)$Y./6!P(!/&.!2$+/!.9.3.(!-#(/&+!of 2011, the total investment in commercial properties increased by 30.3% yearonyear (yoy) to 533.1 billion yuan.

Looking forward, our experts expect that ongoing urbanization, the expansion of service industry as well as the emergence of metropolises will continue to attract property developers to invest in commercial properties. Yet, investment bubbles in commercial property sector should not be overlooked. Property developers and investors are advised to focus more on operational excellence and innovation.

Important trends in 2012

1. Property developers and investors are turning their eyes to the commercial property sector

Property developers and investors have been diversifying their investments into the commercial property sector, amid a series of tightening measures by the government to curb speculation in the residential property market since 2009. (Major tightening measures are shown in Exhibit 1.)

According to a report published by the Ministry of Land and Resources, appreciation of overall land 8$'0.! '(! /&.! +.0#(,! <=)$/.$! #"! @ABB! C)+! 9)$:.94! ,$'3.(! >4! +/$#(:! ,.-)(,! "#$! 0#--.$0')9! 9)(,+G!particularly in lowertier cities. The increase of commercial land prices outperformed the residential sector in Beijing, Shanghai, Guangzhou, Shenzhen and 14 other major cities.

Exhibit 1: Tightening measures on property market

G.+.#3.$#.<='#.-.(/$! \! D#$! /&.! +'1/&! /'-.! '(! /&.! 2$+/! &)9"! #"! @ABBG! /&.! Z.#89.*+! h)(Y! #"!ratio %&'()! IZhR%J! '(0$.)+.,! /&.! $.+.$3.! $.<='$.-.(/! $)/'#! ITTTJ! "#$! '/+!

commercial lenders by 50 basis points to record 21.5%. In December 2011, PBOC cut the RRR by 50 basis points.

Bank interest rates! \! D#$! /&.! /&'$,! /'-.! '(! /&.!2$+/!+.3.(!-#(/&!#"!@ABBG! /&.!ZhR%!$)'+.,!the benchmark oneyear lending to 6.56%.

Credit tightening! \! T)'+.!-'('-=-!,#C(!8)4-.(/!"#$!+.0#(,;&#-.+!"$#-!dAc!/#!5Ac6!! \! M./!&#-.!-#$/:):.! '(/.$.+/!$)/.!)/!(#! 9.++!/&)(!BBAc!#"!>.(0&-)$Y!

rate. Tax! \! d6dc!>=+'(.++!/)1!)889'.,!/#!8$#8.$/4!$.;+)9.!C'/&'(!d!4.)$+6!! \! Z$#8.$/4!/)1!'(!M&)(:&)'!)(,!%&#(:<'(:?!)(,!/&.!/)1!C'99!9'Y.94!>.!"=994!

implemented in other cities later.



Purchase limitation! \! U18)(,!8=$0&)+.! 9'-'/! #"! $.+',.(/')9! 8$#8.$/'.+! "$#-!2$+/;/'.$! 0'/'.+! /#!more second and thirdtier cities.

Public housing! \! M8..,!=8!/&.!0#(+/$=0/'#(!#"!)""#$,)>9.!8=>9'0!&#=+'(:6!! \! P(3.+/! B6b! /$'99'#(! 4=)(! /#! >='9,! /.(!-'99'#(! )""#$,)>9.! &#-.+! "#$! 9#C;

income earners. ! \! U(+=$.!eAc!#"!9)(,!+=8894!:#.+!/#!8=>9'0!&#=+'(:!)(,!+-)99!)(,!-',;

+'V.,!W)/+6!Home price control ! \! L+!)/!N)(=)$4!@ABBG!5Af!0'/'.+!)((#=(0.,!&#-.!8$'0.!0#(/$#9!/)$:./+!target with the growth of the home price is set to be lower than growth in local GDP or disposable income. Source: Compiled by Li & Fung Research Center

2. Ongoing urbanization and the emergence of metropolises will continue to fuel the demand for commercial properties

Urbanization has long been one of the key drivers of China’s economic growth over the past years. In 2010, China’s urbanization rate was 47.5%. It is estimated that the urbanization rate in China would reach 61.9% by 2030, and around 905 million Chinese citizens will live in cities. With ongoing urbanization, expansion of the service industry, as well as rapid development of infrastructure including public transport, utilities supplies, telecommunications, and culture and leisure facilities, consumption environment in smaller towns and cities will improve a great deal. This will help unleash the huge pentup consumption demand as well as stimulate investment in commercial properties.

On the other hand, the emergence of metropolises in China is another major boost. Take the rise of worldclass cities in China as an example, cities such as Beijing and Shanghai have strived to become worldclass cities in recent years. For instance, Beijing has recently positioned itself as a “world city” (üýÔþr ) as well as an “international commercial hub”. This would undoubtedly stimulate the development of the commercial property sector.

Large scale urban renewal and reconstruction projects are also translating into opportunities galore for commercial property investors and developers.

3. “HOPSCA”(567&8 ) and discount outlets are gaining popularity

HOPSCA

_]RZM%L`!+/)(,+!"#$!&#/.9G!#"20.G!8)$YG!+&#88'(:!-)99G!0#(3.(/'#(!0.(/$.!)(,!)8)$/-.(/6!]RZM%L!'+!a large scale multifunctional or complex development concept serving a wide range of purposes from residential, commercial, retail to entertainment.

P(! $.0.(/! 4.)$+G!]RZM%L!8$#[.0/+!&)3.!>..(!+8$#=/'(:! '(! 2$+/;/'.$! 0'/'.+! +=0&!)+!h.'['(:G!M&)(:&)'!and Guangzhou. Today, many secondtier cities such as Chengdu and Shenyang have also included



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HOPSCA plans in their respective city development plans. For instance, more than 55 HOPSCA 8$#[.0/+!)$.!=(,.$!8'8.9'(.! '(!M&.(4)(:G!)00#=(/'(:! "#$!)! /#/)9!)$.)!#"!BAAGAAA!+<6-?!-#$.! /&)(!fA!]RMZ%L!8$#[.0/+!C'/&!)!/#/)9!)$.)!#"!BA!-'99'#(!+<6-!)$.!)9+#!=(,.$!0#(+/$=0/'#(!'(!%&.(:,=6!!

Many property developers can better manage the investment risks and returns with a more balanced 8$#[.0/!8#$/"#9'#6!M)4G! $.+',.(/')9!=('/+!)(,!#"20.!+8)0.+!&.98!:.(.$)/.!&':&! $.(/+!)(,!8$#2/+G!C&'0&!0)(!0#-8.(+)/.!"#$!#8.$)/'#(!9#++.+!#"!/&.!_)(0'99)$4!-)99+`!0#--#(94!+..(!'(!/&.!2$+/!".C!4.)$+!,=.!to high vacancy rates. Lack of differentiation and sound management, however, are the potential risks for many HOSPCA projects in lowertier cities.

Discount outlets

Investment boom in discount outlets is giving a major impetus to China’s commercial property sector as well. It is estimated that China has more than 200 discount outlets, far exceeding that of the total number in the United States.

That said, discount outlets in China are not as mature as those in many foreign countries, where 0#(+=-.$+!0)(!.)+'94!2(,!2$+/;/'.$!>$)(,+!)/!>':!>)$:)'(+6!K)(4!,'+0#=(/!#=/9./+!'(!%&'()!0#=9,!#(94!attract lesserknown brands. Besides, the problem of counterfeit products also hurts the image of discount outlets.

4. Investment boom in commercial properties may lead to oversupply in the market; industry experts and government authorities express concerns over investment bubbles

It is reported that Dongguan will have 69 shopping centers with a total construction area of 3.5 million +<6-!>4! /&.!.(,!#"! @ABB?!M&'[')V&=)(:!)(,!H='4)(:!C'99! )9+#! &)3.!-#$.! /&)(!@A!)(,!Fb! +&#88'(:!0.(/.$+! >4! @ABB! C'/&! )! /#/)9! 0#(+/$=0/'#(! )$.)! #"! @6b!-'99'#(! +<6-! )(,! @!-'99'#(! +<6-! $.+8.0/'3.946!!L00#$,'(:! /#! /&.! ()/'#()9! +/)(,)$,G! )(! )88$#1'-)/.94! eGAAA! +<6-! #"! 0#--.$0')9! '("$)+/$=0/=$.! 0)(!satisfy the demand of 50,000 urban residents. Applying this formula, existing shopping centers in Dongguan, Shijiazhuang and Guiyang could meet the demand of 25 million, 16 million and 14 million =$>)(! $.+',.(/+G! $.+8.0/'3.946!7&.!)>#3.!2:=$.+! /#:./&.$!C'/&!:$#C'(:!3)0)(04! $)/.+! '(!0#--.$0')9!properties imply that there may have investment bubbles in commercial properties in some cities.

Indeed, both industry experts and government authorities have expressed concerns over the investment boom in the commercial property sector. With abundant new supplies, industry experts believe the commercial property market will enter a consolidation stage in 2012; a number of commercial properties will be closed down due to high vacancy rates and mismanagement problems. Government authorities also worry about the oversupply of commercial properties in the market and has started to rein in the overheated market. For instance, the China Banking Regulatory Commission signaled the banking sector three times in 2011 not to expand lending credits to the redhot commercial property market.



Investors are advised to focus more on operational excellence and innovation

To avoid headtohead competition, property developers and investors should carefully study the market demand and retail environment before engaging in the commercial property projects. They are advised to pay more attention to property branding and internal management, rather than solely on the scale of the property projects.

P(,..,G!-)(4!.1'+/'(:!-)99!#8.$)/#$+!)$.!$.;8$#29'(:!/#!+/)4!$.9.3)(/!/#!0#(+=-.$+6!Z9)4.$+!)$.!(#C!=(,.$:#'(:! $.(#3)/'#(+! )(,! >$'(:'(:! '(! (.C! /.()(/+!-#$.! "$.<=.(/946! O'"".$.(/')/'#(! )(,! '((#3)/'#(!are key to attract customer footfalls. Retail property operators should look for new concepts and approaches in running their properties.



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56$ 7&.$ 8#"!'/$ -",.9$ "!$ +"-.$ 9)#:.;+0)9.$ #./)'9.#+$ '+$ <=.+/'"(.,$ >4$ /&.$ 8=>9'0?$growing calls for the government to improve regulatory environment

Many largescale retailers in China have relied heavily on hefty slotting fees and other promotion and marketing fees from suppliers as their major source of income. This has aroused great attention among market players as well as the government. Industry experts believe more stringent measures shall be imposed by the Chinese government to promote a fairer competition environment for market players in the coming year.

Retailers levying cumbersome charges on suppliers, causing strain on retailersupplier relationship

In the past, retailers mainly drew their income from direct merchandise sales. But in recent years, many largescale retailers in China have taken advantage of their increasing market power and introduced a variety of slotting fees ranging from new product listing fees, promotion and marketing fees, store decoration fees and management fees, etc. (Exhibit 1); they hope to maximize their interests and pass on their costs to suppliers via imposing these cumbersome charges.

The current regulatory regime cannot cope well with the needs of the distribution sector in China. The lack of stringent regulations has further exacerbated the problem and put strain on retailersupplier relationship. Retailersupplier relationship has worsened over the years. Indeed, disputes between retailers and suppliers had led to a number of litigation cases in the past decade and some renowned retailers were involved.

Exhibit 1: Different types of slotting fees

For new products For mature products Advance lumpsum Barcode fees and new Additional charges to gain payment product listing fee, etc. better visual displayCharges related

Not proportional to Minimum income Promotion and to merchandise

sales revenue guarantee marketing feessales

Proportional to sales Commission revenue Charges unrelated Festival fees, anniversary celebration sponsorships, to merchandise store renovation and decoration fees and contract sales renewal fees, etcSource: Li & Fung Research Centre

7&.$8#"2/$-",.9$"!$9)#:.;+0)9.$#./)'9.#+$'+$("/$+=+/)'()>9.$'($9"(:$/.#-?$'/$'+$hampering the healthy development of the retail sector

7&.!0=$$.(/!8$#2/!-#,.9!#"!9)$:.;+0)9.!$./)'9.$+!'+!(#/!+=+/)'()>9.!'(!/&.!9#(:!$=(6!P/!'+!)9+#!,./$'-.(/)9!



to the healthy development of the retail sector. For instance, instead of seeking ways to improve core competencies as well as provide customers with better shopping experiences, retailers rely heavily on 0#99.0/'(:!+9#//'(:!"..+!"$#-!+=889'.$+! /#!$.)8!8$#2/+6! !L+!)!$.+=9/G!-)(4!$./)'9.$+! '(!%&'()!)$.!8##$94!,'"".$.(/')/.,!)+! /&.4! "#0=+! 9.++!#(!#"".$'(:!=('<=.!-.$0&)(,'+.!)++#$/-.(/6!7&.!8$#>9.-!#"!&)3'(:!highly similar brands and tenantmix remains very common. This is particularly true for bigname department store chains in China.

The fact that the market is crowded with a large number of undifferentiated players has made many retail operators resorted to price competition to boost sales. Discountdriven promotions are hurting /&.!:$#C/&!8$#+8.0/+!#"!-)(46!P(!),,'/'#(G!/&.!0=$$.(/!8$#2/!-#,.9!-)4!.(0#=$):.!'-8$#8.$!>.&)3'#$+!in the retail industry. For example, instead of selling products that could really meet the needs of consumers, some retailers may tend to merchandise products that could get higher slotting fees; this may affect the choices of consumers.

The government is eager to promote a fairer competition environment

To boost the development of China’s retail sector, many industry experts believe the government should pay more attention to the regulatory environment. Indeed, the government has promulgated several regulations to promote a fairer competition environment for market players. The Management Rules on Fair Transaction Between Retailers and Suppliers (³´#·¸#7O¹TXM6º ), which became effective in November 2006, has tried to address the problems of slotting fees. According to the Management Rules, retailers could not charge suppliers additional fees unless it was agreed upon by parties in concern or was +8.0'2.,! '(! /&.!0#(/$)0/+6!K#$.#3.$G! $./)'9.$+!+&#=9,!)9+#!8)4! "#$!)99!#$,.$.,! '/.-+G!.3.(! '"! /&.4!)$.!(#/!sold; the payment must be made no later than 60 days upon receipt of goods. On the other hand, there are provisions to protect retailers’ interests. For instance, suppliers are prohibited from practicing tiein selling. In addition, the government launched the Suggestion on Establishing Payment Disputes Resolution Platforms for Retailers and Suppliers (èéu=³·»$ÿ!"#$$O%×ÕÖ&') in 2009. Retailers and suppliers are encouraged to resolve their disputes in arbitration committee, which is formed by industry members, before bringing their cases to courts.

Nevertheless, the results of the above measures are in doubt and there remains much room for improvement, particularly on the enforcement front. Still, the strained retailersupplier relationship in China has caught the attention of many.

Growing calls for more stringent measures and better enforcement

Our experts believe retailersupplier relationship is crucial for the healthy developments of the retail sector. They think that more stringent measures should be in place to restrain largescale retailers to '-8#+.!=(.<=)9! /.$-+!#(!+-)99!+=889'.$+6!N)8)(*+!L(/';-#(#8#94!m)C!ILKmJ! '+!)!0)+.! '(!8#'(/6!7&.!AML sets out rules to restrain the abusive rights of big retailers. It demonstrates that a comprehensive regulatory regime as well as stringent enforcement of laws are crucial to foster the sustainable development of the retail sector in China.



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7. Pressing need to address the issues of recruiting and retaining employees in retail industry

China is experiencing a retail boom, thanks to a vibrant domestic economy; yet, the growth of the '(,=+/$4!-)4! >.! )"".0/.,! >4! '(+="20'.(/! +=8894! #"! <=)9'2.,! .-89#4..+6!7&.! 0&)99.(:.+! #"! $.0$='/'(:!)(,! $./)'('(:! $./)'9! .-89#4..+! C.$.! '(0$.)+'(:94! /#=:&! '(! @ABB6! K)[#$! ,'"20=9/'.+! )(,! =(,.$94'(:!reasons are as below:

Undersupply of eligible retail workers: As China’s retail industry develops, demand for retail talents is increasing rapidly. Currently, it is estimated that around 80 90 million people work in the industry. The labor supply, however, could not meet the increasing demand in the market. Many retailers could (#/! 2(,! +='/)>9.!8.$+#(+! /#! 299! /&.! [#>! 3)0)(0'.+6! P/! '+! 8)$/'0=9)$94! /$=.! "#$! +-)99! $./)'9.$+!)+! /&.! [#>!3)0)(04!$)/.!0)(!>.!)+!&':&!)+!Bdc!/#!@Ac6!P(!#$,.$!/#!299!/&.!8#+'/'#(+G!+#-.!$./)'9.$+!&)3.!/#!-)Y.!0#(0.++'#(+! >4! 9#C.$'(:! /&.'$! .-89#4-.(/! $.<='$.-.(/+6! 7&'+! '+! .+8.0')994! /&.! 0)+.! "#$! $.0$='/'(:!.18.$'.(0.,!)(,!<=)9'2.,!/#8!-)():.-.(/6!

Low salary and long work hours in retail industry: Long work hours and low salary are the major $.)+#(+! "#$! "$#(/9'(.! $./)'9! +/)""! /#! <='/! /&.'$! [#>+6!L00#$,'(:! /#! )! +=$3.4! 0#(,=0/.,! >4! PhKHG! +/)""!turnover rate in China’s retail sector stayed between 20 30% in recent years. The number is even much higher for some retailers.

H(),.<=)/.$ /#)'('(:$ '($>=+'(.++$+0&""9+I Although there are more than 300 business schools in China and nearly 100 of them provide relevant retail training courses, most of the teachers do not have practical experience in the sector. The discrepancy between the courses offered by the schools )(,!/&.!.18.0/)/'#(+!"$#-!/&.!$./)'9!.(/.$8$'+.+! '+!&=:.6!k.$4!#"/.(G!/&.!:$),=)/.+!,#!(#/!.<='8!C'/&!practical skills as needed for the workplace.

P(!),,'/'#(!/#!,'"20=9/'.+! '(! 9#0)/'(:!)(,!',.(/'"4'(:!/&.!$':&/!0)(,',)/.+G!/&.!&'$'(:!8$#0.++!0)(!8$#3.!challenging as well due to the following four factors: 1) China has reached the Lewisian Turning Point which means the supply of workforce is decreasing1; 2) mentality of the young generation especially the post80s and post90s generation is different from the previous generations. Very often they ask for better payment terms but are reluctant to devote their time and soul at work. The job turnover rate '+!8)$/'0=9)$94!&':&!)-#(:!/&'+!:.(.$)/'#(?!bJ!)+!/&.!:)8!>./C..(!/&.!0#)+/)9!)(,!2$+/;/'.$!0'/'.+!)(,!inland and lower tier cities is narrowing, the younger workforce is more willing to leave the big cities and return to their hometown. It exacerbates the employment problems in the retail sector, particularly "#$!2$+/;/'.$!0'/'.+6!

Facing the above challenges, some retailers have begun to seek remedies via the following means:

B! L00#$,'(:!/#!/&.!.0#(#-'+/!M'$!^'99')-!L$/&=$!m.C'+G!,.3.9#8'(:!0#=(/$'.+n!'(,=+/$')9!C):.+!>.:'(!/#!$'+.!<='0Y94!)/!/&.!8#'(/!when the supply of surplus labor from the countryside tapers off.



1. To cooperate with education institutes as well as recruitment agencies

To recruit and retain talents, some employers have put more resources on their own recruitment programs. A common way is to join hands with other education institutes or recruitment agencies to organize specialized training programs or other team building activities. For instance, Suning, a renowned Chinese home appliances and electronics retailer, has collaborated with some higher education institutes to launch special job training programs for students.

On the other hand, some retailers have formed strategic alliances with recruitment agencies or headhunters to identify and recruit the right talents. Other retailers have rolled out “one to one mentoring scheme” with vocational training schools. On the one hand, it helps solve the employment 8$#>9.-+! #"! /&.! +/=,.(/+6! R(! /&.! #/&.$! &)(,G! '/! )9+#! .()>9.+! $./)'9! .(/.$8$'+.+! /#! 2(,! /&.! $':&/!0)(,',)/.+!C'/&!)99!/&.!(.0.++)$4!<=)9'20)/'#(+!)(,!.18.$'.(0.+6!

2. To build capabilities through internal training

In recent years, many retailers have launched their own internal training programs. Among the top 100 retail enterprises in China, most of them have established their own business schools or internal training centers. Indeed, an increasing number of small and mediumsized retailers have also developed their own training programs, hoping to nurture their own talents.

3. To improve working environment and job remuneration packages

A number of retail enterprises have offered pay rise to their employees, with an average of 10%15% since 2010. Some experts estimated that the average salary of the retail industry will increase at an annual rate of 10%20% in coming years. In addition, some retail employers have started to offer better working environment by introducing work incentives schemes and rewarding schemes.

4. To improve the ways of talent management

According to a study conducted by China General Chamber of Commerce, there is increasing demand "#$! /$)'('(:! '(! /&.! 2.9,! #"! &=-)(! $.+#=$0.+!-)():.-.(/6!K)(4! $./)'9! .(/.$8$'+.+! )$.! 89)0'(:!-#$.!emphasis on performance measurement, development of internal training programs, optimization of organizational structure, staff management, labor cost control as well as enhancement of leadership skills.

J6$ 7"$.(&)(0.$.!20'.(04$>4$"8/'-'K'(:$'(/.#()9$-)():.-.(/$

Some local retailers have made use of technologies to reduce reliance on frontline staffs. For instance, surveillance technologies have been widely applied in retail stores to reduce product loss and C#$Y9#),!#"! "$#(/9'(.!+/)""+6!K.$0&)(,'+.!8=$0&)+.!&)+!)9+#!>..(!0.(/$)9'V.,! '(! /&.!&.),<=)$/.$+! '(!#$,.$!/#!#8/'-'V.!-)():.-.(/!."20'.(046!



34

Labor shortage remains a key challenge for China’s retail industry

Our experts believe that shortage of workers will remain a major challenge for retail businesses. M'(0.! /&.!<=)9'/4!#"! /&.!C#$Y"#$0.! '+! /&.!,.0'+'3.! ")0/#$!#"! 9#(:! /.$-!0#-8./'/'3.(.++!)(,!8$#+8.$'/4!of the retail industry, concerted efforts from policymakers, industry associations, retail enterprises and training institutes are therefore necessary to break the bottlenecks.



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8. Pilot tax reform program on logistics sector sets to strengthen the operating environment

l.)$!@ABA;BB!-)$Y.,!,'"20=9/! 4.)$+! "#$! /&.! 9#:'+/'0+! '(,=+/$4! '(!%&'()6!7#/)9! 9#:'+/'0+! 0#+/+! '(!%&'()!continued to climb; excessive highway tolls, price hikes of fuel and labor as well as slackening demand C.$.!#>+.$3.,6!L99!/&.+.!8#+.,!&=:.!8$.++=$.!#(!/&.!8$#2/)>'9'/4!#"!9#:'+/'0+!.(/.$8$'+.+6!P(!),,'/'#(G!given the fragmented nature of China’s logistics industry, several government departments are responsible for monitoring different aspects of the logistics industry, and the taxes they levy also push up the operation costs.

The Chinese government has put forward a number of supportive measures in recent years to help improve the operating environment for the logistics sector. One area that we expect to see dramatic change is the tax regime. Our experts believe that the proposed tax reform will lessen the heavy tax burden of logistics enterprises, and eventually leading to a better operating environment.

Logistics challenges – differential tax rates and overlapping taxation leading to heavy tax burden

Industry players have long criticized the differential Business Tax rates levied on various logistics functions within the logistics industry. Currently, logistics enterprises that span different parts of the supply chain have to pay multiple taxes to different bodies at different rates. For instance, companies engaging in transport and communications businesses pay Business Tax at a 3% rate, while others such as warehousing and freight forwarding, pay 5%. The differential tax rates not only complicate /&.!:#3.$(-.(/*+!/)1!0#99.0/'#(!8$#0.++G!>=/!)9+#!-)Y.!'/!,'"20=9/!"#$!'(/.:$)/.,!9#:'+/'0+!.(/.$8$'+.+!/#!calculate the taxes they need to pay as many logistics functions are often interlinked and it is hard to distinguish the nature of the function.

On the other hand, different tax rates levied on different business activities may easily result in overlapping taxation. Logistics companies that outsource some of their business services to thirdparty providers are mostly affected. For instance, when an integrated logistics company outsourced its services to a thirdparty provider, both companies are also subject to Business Tax; as a result, the same business activity is double taxed. Overlapping taxation not only increases the tax burden of the companies, but also hinders the development of the logistics industry.

Supportive measures to reform the tax regime

The government recognized the need for a change of the tax regime and in 2011, it has introduced a number of supportive policies, hoping to lessen the tax burden of logistics enterprises and facilitate further development of the industry. Among which include the eight supportive measures (commonly known as the “Eight Measures”) announced by Premier Wen Jiabao in a State Council executive meeting held in June 2011, as well as the pilot Valueadded Tax (“VAT”) reform program in Shanghai replacing Business Tax with VAT in the transport and logistics industry.



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The Eight Measures Unifying Business Tax rates being the top priority

In June 2011, the State Council announced the Eight Measures (please refer to Exhibit 1 for the highlights of the Eight Measures). One of the top priorities is to implement concrete measures to lessen logistics enterprises’ heavy tax burden. The government would implement a pilot program that eliminates multiple collections of taxes in the logistics sector, and unify Business Tax rates on different parts of the supply chain i.e. warehousing, distribution, freight forwarding and transport.

VAT to replace Business Tax in Pilot Project in Shanghai

Another big step forward is the implementation of a pilot program to replace Business Tax with VAT. The Ministry of Finance and the State Administration of Taxation jointly issued a circular in November 2011, outlining the implementation and transition rules of the pilot program. The pilot program rolled out in Shanghai on 1 January 2012, focusing primarily on the transportation, logistics and modern services industries. The objective is to reduce the double taxation caused by separate VAT and Business Tax, and enable a fairer VAT input deduction system.

Two lower tax rates of 11% and 6% will be added to the existing standard VAT rate of 17% and the lower rate of 13%. The VAT rate applicable to transportation service1 is 11%, which deviated a great deal from the expected rate of 5%. Given the current rate of Business Tax on transportation services is 3%, and that the nature of transportation companies does not provide for many chances for taxpayers to claim input VAT credit (does not provide much opportunity for the offset of VAT incurred), many industry experts believe that the real cost of transportation services is likely to increase; thus, the '-8)0/!#"! /&.!8'9#/!8$#[.0/!#(! /$)(+8#$/)/'#(!0#-8)('.+! $.-)'(+!=(0.$/)'(6!O.8.(,'(:!#(! '/+!+8.0'20!cost structure, one company could be worse off or better off.

Looking on the bright side, the VAT rate on logistics and other ancillary services2 is 6%; this surely will lessen the tax burden on warehousing and freight forwarding companies. If the pilot program is successful and the conditions are right, we believe the policy will be extended to other service businesses nationwide.

1 Transportation services include land, sea, air and pipeline transportation. It includes road transportation, passenger and cargo transportation as well as time charter services and wetlease operations. (Source: KPMG)

2 Logistics and ancillary services refer to air services, port services, freight and passenger transportation (excluding railway) terminal services, salvage rescue services, freight forwarding services, customs clearance services, warehousing services and materials handling services. (Source: KPMG)



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Improvement in operating environment

Apart from the proposed tax reforms, the government has also formulated other policies to boost the development of the logistics industry. For instance, the following areas are also highlighted in the Eight Measures: land use support, reduction of road tolls, improvement in logistics management, integration of logistics resources, application of innovative technology, investment in logistics infrastructure and 2()(0.!0&)((.9+G!)(,!,.3.9#8-.(/!#"!,'+/$'>=/'#(!(./C#$Y!#"!):$'0=9/=$)9!8$#,=0/+6!R=$!.18.$/+!>.9'.3.!that all these measures will better the overall operating environment for the logistics sector.

Exhibit 1 The Eight Measures announced by the State Council

In June 2011, the State Council announced the Eight Measures, aiming to enhance the overall performance of the logistics industry in China. Listed below are the major themes of the Eight Measures:

1. Lessen the tax burden of logistics enterprises by implementing a pilot program that eliminates multiple collections of taxes in the logistics sector and unifying Business Tax rates on different parts of the supply chain;

2. Improve landuse policies by guaranteeing land for logistics parks and encouraging the expansion of warehouse sites;

3. Reduce highway tolls and extend electronic toll collection systems;4. Simplify approval procedures for logistics practices and systems; d6! U(0#=$):.! /&.! '(/.:$)/'#(!#"! 9#:'+/'0+! $.+#=$0.+!)(,! ")0'9'/'.+?! 9#:'+/'0+!2$-+!)$.!.(0#=$):.,! /#!

integrate their resources by forming strategic alliances;6. Promote technological innovation in the logistics industry;7. Encourage local governments to increase investment in logistics infrastructure and develop

2()(0'(:!0&)((.9+!"#$!9#:'+/'0+!0#-8)('.+?8. Encourage sizeable logistics enterprises to put more emphasis on the distribution network of

):$'0=9/=$)9!8$#,=0/+!+#!/&)/!")$-!8$#,=0.+!0)(!>.!-#3.,!/#!-)$Y./!."20'.(/946!146".#7''/&&2788999:..0.*:.4,8;/&,0*#9;30#;8#.4,*#9;8<=>8?@AA8?@AABAC@A@><ACB@AC:;/&,0D'E%'F'G6*+'H#;#)"./'!#*&#"'



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9. Increasing supply of governmentbacked wholesale and logistics facilities sets to lower distribution costs

With vast geographical span and huge regional differences, distribution in China has long been a challenging task. The costs of distributing goods in China are huge as goods often need to pass through many tiers of distributors before reaching the end consumers. Moreover, high logistics costs also add further burden to many distribution companies. As China strives to build a more consumptiondriven economy, the country’s distribution sector is grasping increasing attention, both from the market as well as the government.

In recent years, the Chinese government has stepped up its efforts to improve the distribution sector. A major initiative undertaken by the government is to provide more affordable distribution facilities and infrastructures such as warehouses, logistics centers, wholesale markets as well as information platforms for the public. This not only can help lower the distribution costs in China, but can also improve people’s livelihood.

Liberalization of China’s distribution sector and various operation modes of distribution facilities

Prior to the economic reform in 1978, China’s distribution sector was regulated and controlled by the Chinese government, in order to secure rationing of a wide range of food and consumer goods in short supply. Most of the consumer goods were delivered through the Supply and Marketing Cooperatives (·É&+b ) or governmentcontrolled wholesale and retail systems. Product distribution was primarily supplypushed.

After 1979, the degree of central planning has been gradually reduced. China’s entry to the World Trade Organization (WTO) in 2001 brought further market liberalization. In 2004, foreign distribution companies were allowed to enter the market. Nowadays, the facilities in China’s distribution sector are dominated by three major operation modes.

Distribution facilities and infrastructures: three major modes of operation

1. Governmentowned: Facilities for daily necessities such as grain, seed and oil warehouses are often whollyowned by the government and those assets are managed under relevant government bureaus or stateowned enterprises. The main benefit of investing in distribution facilities is that it allows the government to regulate the retail prices of key commodities.

2. Governmentsubsidized: The government will shoulder part of the distribution costs by building affordable facilities and infrastructures such as agricultural produce wholesale markets by means of providing capital grants, concessional loans and tax incentives.



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3. Privatelyinvested: Some facilities are held by the private sector and run under commercial operations. Those facilities range from cold storage and temperature controlled warehouses, logistics centers, distribution centers to wholesale markets.

High distribution costs remain a major concern in China’s distribution sector

Nowadays, the "hard to sell and expensive to buy" problem remains an outstanding issue across the 0#=(/$46! ]=:.! ,'+/$'>=/'#(! 0#+/+! )+! C.99! )+! /&.! 8$#2/! -)1'-'V)/'#(! >.&)3'#$! #"! +/)Y.&#9,.$+! '(! /&.!distribution sector have drawn awareness from the public. Some experts urged the government to strengthen its roles in the distribution sector.

Indeed, many distribution facilities in Western countries are operated by the governments as part of the public services and social welfare provision. For instance, 30 out of 34 wholesale fruit markets in the United Kingdom were built with government subsidies; 23 wholesale markets for agricultural produce are run by the government in France and some of them are taxexempt; the United States government has also widely invested in the information networks of the distribution sector since 1990s.

The Chinese government taking steps to provide more affordable wholesale and logistics facilities

In China, the government has taken steps to strengthen its role in the distribution sector and to provide more distribution facilities and infrastructures. In 2011, the State Council issued the Opinions on Strengthening the Building of Fresh and Agricultural Produce Distribution System (èéÐ()*+ÇÈtYuv×&' ) , urging governments at all levels to increase investment in wholesale markets for ):$'0=9/=$)9!8$#,=0.6!L00#$,'(:! /#! /&.!R8'('#(+G! 9#0)9!:#3.$(-.(/+!)$.! $.<='$.,! /#!>='9,!)(!."20'.(/G!safe and regulated distribution system for agricultural produce in a bid to lower the prices of farm products. They are also urged to put more resources on boosting the country’s logistics capabilities and provide better linkage between producers and consumers so as to cut intermediary costs. Beijing is one of the pioneering municipalities and cities that has started to formulate plans to help boost the development of agricultural produce distribution system. Beijing plans to hold stakes in 10 vegetable -)$Y./+!)(,!8=$0&)+.!23.!3.:./)>9.!-)$Y./+!'(!.)0&!#"!/&.!0'/4n+!,'+/$'0/+!'(!/&.!"=/=$.6!

Indeed, to improve the livelihood of the vast rural population, the Mainland authorities have actively taken a series of initiatives to improve the rural distribution landscape over the past few years; of which the Rural Retailing Network Project (,-./*0 ) and the Agricultural Produce Wholesale Market and Distribution Company Development Project (12rs*0 ) are two major projects launched by the Ministry of Commerce (MOFCOM). In a bid to modernize the country’s agriculture sector, in 2009, MOFCOM, the Ministry of Finance and the Ministry of Agriculture jointly issued the Pilot Scheme Notice of Promoting Closer Cooperation Between Farmers and Supermarkets (èéÏE+Ý34ÕÖ*+×¨Ø ) in 15 provinces where conditions for directfarm sourcing are considered relatively mature. Government funding of 400 million yuan has been allocated to support 200 retailer



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directfarm sourcing projects in areas such as improving cold chain logistics, distribution centers, <=)9'/4! +=$3.'99)(0.! )(,! >$)(,! >='9,'(:6! P/! '+! &#8.,! /&)/! >4! @AB@G! 8)$/'0'8)/'(:! $./)'9.$+! 0)(! ,'$.0/94!source more than 50% of their agricultural products.

Improving the distribution landscape will continue to top the government agenda

Improving the distribution landscape will continue to top the government agenda in the next few years. It is believed that increasing participation of the government will help lower the distribution costs in China. Industry experts, however, believe the government should be selective when investing in or subsidizing the distribution facilities. Ownership rights according to the Property Law should be duly respected and considered.



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10. Growing calls to lower business costs for China’s commercial and service sectors; more supportive measures are expected

In recent years, many commercial enterprises in China have been feeling the chill of rising business 0#+/+6!R(!#(.!&)(,G! '(W)/'#(!)(,!-)$Y./! 0#-8./'/'#(!&)3.!,$'3.(!=8!#3.$&.),!0#+/+!+=0&!)+! 9)>#$!and rental costs; on the other hand, high tax burden and excessive fees also push up business costs. There are some structural issues behind the high transaction costs facing distribution sector which are inherent in the country’s policy framework. Industry players have urged policy makers to help lower the cost of doing business in China; in fact, the government realizes that high transaction cost will hinder the development of the commercial sector and has taken several steps to alleviate the problems.

Higher tax burden and excessive charges adding to the burden of commercial enterprises

The Chinese government imposes a heavy tax burden on individuals and businesses (particularly service industry). Apart from Individual Income Tax (“IIT”) and Corporate Income Tax (“CIT”), individuals and enterprises need to pay many other indirect taxes such as Consumption Tax (“CT”), Valueadded Tax (“VAT”), Business Tax (“BT”), to name but a few.

Among different industries, the service industry bears the heaviest tax burden. In 2010, the contribution of China’s domestic trade sector to GDP was 10.6%; however, tax revenue for domestic trade accounted for 18.3% of the national tax revenue in the same year. Currently, China’s commercial tax burden is well above 25%. According to the State Administration of Taxation, the tax rate for service industry will increase by 2% per year in the coming years.

There are some structural issues leading to higher transaction costs facing the commercial enterprises which are inherent in the country’s policy framework. One of the most commonly discussed issues is the difference of electricity tariff between residential, industrial and commercial users. Commercial enterprises are charged the highest tariff – according to China International Capital Corporation Limited, they need to pay 43% more for their utility bills than the industrial enterprises. High electricity >'99+! +=$.94! .)/! '(/#! /&.! 8$#2/+! #"! -)(4! 0#--.$0')9! .(/.$8$'+.+6! P(! $.0.(/! 4.)$+G! /&.! :#3.$(-.(/!has sought to resolve the issue by asking provincial grid companies to standardize the tariff for all endusers. The grid companies, instead, adopted the peak/valley tariff system (or timeofuse pricing system). This has little impact on commercial enterprises; unlike industrial enterprises, most commercial enterprises cannot avoid operating in the peak hours i.e. 10am10pm.

On the other hand, the higher land cost is another structural problem facing commercial enterprises. As most commercial businesses are located in residential communities or business districts, the skyrocketing land prices have prevented many enterprises from buying the land and building their own premises. Moreover, the current land auction system adopted by most of the local governments also helps push up the land price as the majority of the leasehold rights would be sold to the highest bidders.



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Another typical structural problem facing many commercial and distribution enterprises is high logistics cost. Take the trucking industry as an example, truck drivers in China not only need to pay the high toll fees, they are also bound by a host of regulations. For instance, they are limited by the number of hours they may drive, the roads and highways they may drive upon, etc. All these translate into high operation costs.

Growing calls to lower business costs for China’s commercial sector

Policymakers, in fact, recognize that high transaction costs may hinder the development of China’s distribution sector and have taken some preliminary steps to alleviate the problems.

D#$! '(+/)(0.G! 0=$$.(/94! -)(4! +-)99;+'V.,! .(/.$8$'+.+! )$.! ")0'(:! &=:.! 2()(0')9! +/$)'(+! )-',! $'+'(:!production costs and sluggish export demand; in view of this, the government announced a number of supportive measures in late 2011 to give a hand to the smallsized enterprises, including raising the threshold of VAT and exempting administrative fees.

\! U"".0/'3.!B!Q#3.->.$! @ABBG! /&.! /&$.+&#9,+! "#$! 9.34'(:!kL7!)(,!h7!#(! +-)99;+'V.,!.(/.$8$'+.+!were being lifted. The VAT threshold for small enterprises will be increased to between 5,000 20,000 yuan, in terms of monthly sales revenues, from the previous threshold of 2,000 to 5,000 yuan. Meanwhile, the threshold for levying the BT for smallsized enterprises will be raised to 5,00020,000 yuan from the previous 1,0005,000 yuan1.

\! 7&.!Q)/'#()9!O.3.9#8-.(/! )(,!T."#$-!%#--'++'#(!)(,! /&.!K'('+/$4! #"!D'()(0.!)((#=(0.,!on 14 November 2011 that micro and small enterprises will be exempted from 22 types of administrative fees such as Enterprise registration fees, Tax invoices fees, Customs supervision "..+G!D..+!#(!R$:)('V)/'#(!%#,.!%.$/'20)/.+!)(,!.(,#$+.-.(/G!)+!C.99!)+!'++=)(0.!#"!H.(.$)9!%.$/'20)/.+!#"!R$':'(G!./06G!"$#-!B!N)(!@AB@!/#!bB!O.0.->.$!@ABF2.

Our experts generally welcome the government’s initiatives to lower the overall business costs; they believe the government has taken a big step forward in driving the development of the commercial sector. Having said that, many of the government measures are indeed being piecemeal in nature; there are still growing calls for more comprehensive planning. It is hoped that the government would come up with a raft of comprehensive measures during the upcoming National Work Conference on Distribution held by the State Council in early 2012.

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