China’s Two Markets
In this podcast, Jack and Doug Perkowski discuss how China’s lower cost perspective, in combination with the way in which the country has developed economically over the past 40 years, has created two markets in the country—a purely local market that is characterized by low price and low technology and a foreign/local market that is characterized by high price and high technology. If you want to sell your products in China, this podcast is a must.
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Excerpt: “The China market is very fragmented. In any product that has a certain amount of technology, there are perhaps a half dozen companies around the word that make the same product. Yet, when you come to China, there are 500, 700 or 1000 companies making that product. The reason is the existence of the large, and growing local market.” Listen or read on to find out more.
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Jack: In our podcast about the different—and lower—cost perspective that exists in China, I mentioned that China’s lower cost perspective, in combination with the way in which the country has developed over the past forty years, has created a market for most products, which is now the largest market in the world, but which operates much differently than the other large market in the world—the market in the United States.
For example, you might wonder why a product with any level of technology might has a half dozen companies around the world making that product, yet, when you come to China, there might be 500 or 1000 companies making the same product, or one that is functionally similar. A few examples. While the global auto industry has consolidated from 30,000 to no more than 10,000 suppliers over the years, upwards of 6,000 Chinese companies apply every year to display their products at the Beijing or Shanghai auto show. There are over 80 million private companies in China. There are literally hundreds of thousands of auto repair shops in the country, and millions of restaurants.
What gives rise to this phenomenon? To understand how China’s markets have developed, you need to go back to an earlier point in time when the market was much simpler. Let’s go back to 1988, and ask ourselves what the market for any product looked like at that time.
If I asked you to describe the China market in 1988, you’d tell me that you need more information. In 1988, China’s GDP was about $300 billion, and the country had a billion people. Therefore, the average per capita income was about $300, obviously not very high. I wasn’t in China in 1988, but, given these facts, I think that I can safely describe what the market for any product looked like at that time.
While China opened up to the outside world ten years earlier in 1978, and a number of companies from Hong Kong and Taiwan had set up factories in China’s Special Economic Zones, by and large, most of the products being made in China were made at purely local factories in 1988. While China had begun to export products by 1988, most of the products made by Chinese factories were still being purchased by local companies and consumers. In other words, in 1988, China was a completely local market from both a production and a consumption point of view, where the products being produced and sold were at the low end in terms of price and technology. Why at the low end? Well, per capita income was only $300, and I think you would agree that you can’t buy much with that amount of money.
Now, let’s fast forward to 2018. Last year, China’s GDP was about $12.2 trillion, a big, big increase from 1988; and China had about 1.3 billion people. Therefore, per capita income was over $8,500. But when you look at China, you need to consider that different segments of China’s population have vastly different income levels. For example, of China’s 1.3 population, there are about 300 million people that live in the countryside work in the country’s agricultural sector, and about 300 million migrant workers. All those beautiful buildings that you see in Beijing and Shanghai were built by migrant workers from the country’s villages who typically leave home to work for a few years, but then go back to their villages and hometowns in the countryside.
If you do the numbers, the average per capita income for those 600 million people is about $4,500, a lot different than the national average of about $8,500. Well, you might say, there are another 700 million people, where did they go? They moved up—and they formed a completely new market which I call the foreign/local market, where the average per capita income is much higher at about $14,500. Why do I call it the foreign/local market? I call it that because, when foreign companies come to China, this is the market they focus on. In terms of price, quality and technology, the products sold in the foreign/local market look a lot like the products that are sold in their home markets.
So, China’s 1.3 billion population is divided roughly between 700 million people who live in the cities and have much higher per capita incomes, and 600 million people who live in the countryside and have per capita incomes that are much lower than the national average. Admittedly, an average per capita income of $4,500 in the local market is much higher than the $300 in 1988, but it is still not high enough to buy products with the highest technology and quality. Therefore, products in this purely local market have to be cheap and affordable.
Summing it all up, the China market actually consists of two markets—a foreign/local market that is characterized by high price and high technology, and a purely local market that is characterized by low price and low technology. In the foreign/local market, foreign companies compete with other foreign companies and the best of the local Chinese companies, while the local market is virtually all local companies. The interesting fact about the local market is that it keeps growing. As China’s economy grew from $300 billion in 1988 to $12.2 trillion in 2017, the foreign/local market got established and grew, but the local market also grew larger.
Doug: Can you give me an example of an industry where this concept of China’s Two Markets has played out?
Jack: When I first started thinking about how China’s markets worked, the industry that hit me as being a good example is the restaurant industry.
Several years ago, my younger daughter, Libby, came to visit and it happened that her birthday fell during her trip, giving us the rare opportunity to celebrate in person. With Libby in town, we booked a table at the Courtyard, one of our favorite restaurants in Beijing—you’ve been there, Doug. The Courtyard’s setting couldn’t be any more spectacular. It’s located just opposite the East Gate of the Forbidden City, and it was one of the first upscale, Western, stand-alone restaurants to be built in Beijing. In addition to having a spectacular view and very nice interior furnishings, the food at the Courtyard is excellent. Rey Lim, the chef, worked at Bouley in New York and is a good friend.
Anyway, we had a fantastic meal, and Libby told me afterward that she considers the Courtyard to be
one of her favorite restaurants in the world, not just in Beijing. Prices at the Courtyard, naturally, are also what you’d expect to pay at a fine restaurant in New York, Paris or any other major international city. With a nice bottle of wine, the bill at that time came to about $100 per person. The Courtyard and restaurants like it are a good example of what I call the foreign/local market—high price, but also high quality and high technology in terms of food.
Right about that time, a good friend of ours came to Beijing with his wife, and we decided to take him to a good local restaurant. We took them to a restaurant that you know well, Doug, a local dumpling restaurant near the office that everyone loved. Before we went, we asked Henry Huang from our company, who we call our CFO—our Chief Food Officer, to write out an order. Henry knows food and he knows that restaurant well.
For six people, Henry ordered five plates of dumplings: fried dumplings, dumplings stuffed with pork and cabbage, pork and coriander dumplings, tomato and egg dumplings, and dumplings stuffed with pork and beans. He also included two cold dishes as starters, as well as a tomato and egg dish, an eggplant dish, and a spicy bean dish to eat with the dumplings. To wash it all down, we ordered five Diet Cokes and one bottle of water. Each plate contained about fifteen dumplings, so we had more than enough to eat.
As we waited for the check, we played the traditional “How much will the bill be?” game. Obviously it was a lot of food, and the food was fantastic, so our friend’s first guess was in the area of 500 yuan. Of course, we had to tell him that his guess was way too high. As it turned out, the bill came to about 137 yuan, barely $3.00 a person! The dumpling restaurant is an example of what I call the local market. There are literally millions of restaurants like it in China where you can get a great deal of food at a cheap and affordable price.
A couple of days later, while our friends and Libby were still in town, another friend of ours, who happened to run the Hilton hotel in Beijing, was taking a group of people to the Li Qun Roast Duck restaurant. Everyone who has been to Beijing has, of course, had Beijing Duck, and Li Qun is one of the best duck restaurants in the city. It’s very famous restaurant, and when you walk in, the entry is lined with pictures of ambassadors and other important people who’ve eaten there over the years. It’s an example of a high end Chinese Restaurant.
There were twelve of us that ended up at Li Qun, and we had another great meal. We ordered three ducks, a spicy pork dish, plates of broccoli and eggplant, and two orders of fried duck bones, which is a specialty. Along with our meal, we had five large bottles of Yanjing beer. For twelve people, our bill came to 647 yuan, or about $8 per person.
So, these three restaurants illustrate perfectly what I say about China’s two markets—$3, $8, $100 for the price of a meal. The dumpling restaurant is an example of the purely local market. Low price, and good food, but simple in terms of the technology of food. In the foreign/local market, there is the Courtyard, but then there are also the Li Qun’s of the world, which are purely local restaurants that also compete in the foreign/local market. Li Qun is not as high priced as Courtyard, but, like the Courtyard, it serves a broad market, including foreigners and locals, and is higher priced than restaurants like the dumpling restaurants that cater primarily to the local market.
Doug: The restaurant industry is a bit specific. Certainly, there is a range of prices in China that is unmatched. But, you mentioned technology. How about an industry where technology is a factor?
Jack: Let’s take electric vehicles (“EVs”). In 2017, China produced 770,000 electric vehicles and led the world in this important category. But, that’s not the whole story, because every year, over 1.3 million low speed EVs are sold in China’s lower tier cities. What are low speed EVs? Basically, they are EVs that are limited to 80 kilometers per hour in terms of speed, and are not allowed on certain roads such as major expressways.
The way this market developed is very interesting, and is another illustration of China’s two markets.
Just like in the United States, the average EV passenger car costs $35,000 or more in China, and certainly, higher income consumers in the Beijing’s and Shanghai’s of the world can afford them. The EVs that fall into the 770,000 category are every bit as technologically developed as the EVs you would find in the United States or Europe. However, if you travel to the countryside and China’s lower tier cities, you will see whole families on a motorcycle—the mother, the father, the child and a bag of groceries. And, if it rains a lot in that province, they will have an umbrella attached. That family cannot afford $35,000 for an EV, but they can afford $5,000. And, they don’t need to go fast or go far. They only need to get to the other side of town.
Meanwhile, the leaders in these provinces would like to have their citizens to have safer and more convenient transportation, but they don’t want hundreds of thousands of cars powered by internal combustion engines adding to pollution. Over the past five or six years, an entirely new industry has grown up and over 100 companies, many in Shandong Province where this has all started, have invested billions of dollars to build low speed EVs that use conventional—and much cheaper—- lead acid batteries. Low speed EVs sell for about $5,000.
Once again, this is an example of China’s two markets at work. China’s overall EV industry consists of a foreign/local market, with 770,000 conventional EVs that have prices and technology levels exactly comparable to what you would find in the United States and Europe, and a much larger, purely local market, with more than 1.3 million low speed EVs being produced and sold each year. While low speed EVs have a much lower level of technology than conventional EVs, they meet the affordability requirements of the local market.
Doug: if I’m an executive looking to get into China, what conclusions can I draw from the existence of the two markets in China?
Jack: The first conclusion is that as big as you thought the China market is, it’s even bigger. If someone asks about the size of China’s EV market, you might say 770,000 units a year. But, I would say it’s actually much larger—it’s already more than two million vehicles.
The second conclusion is that the market is fast growing—China’s GDP grew from $300 billion to $12.2 trillion in thirty years. All industries, and both the foreign/local and the local markets, have grown larger as a result.
The third is that the China market is very fragmented. In any product that has a certain amount of technology, there are perhaps a half dozen companies around the word that make the same product. Yet, when you come to China, there are 500, 700 or 1000 companies making that product. The reason is the existence of the large, and growing local market.
Take ASIMCO’s piston ring business as an example. This is the same factory where they built a nice twenty story hotel that I talked about in our podcast on China’s Different Cost Perspective. Every year, the factory makes about 40 million piston rings a year, which makes it one of the largest in China, and one of the largest in the world.
A number of years ago, we did a market study, and found that our factory and our two largest competitors accounted for about 60% of the market. Yet, there were 180 companies in China making piston rings. Five years later, when we repeated the study, we found that there were more than 400 companies in the market place. You would think that with the need for consolidation, the number of companies would have gone down, not up, particularly in view of the fact that there are only a handful of serious piston ring manufacturers in the rest of the world.
The answer is simple. Because piston rings are essential to controlling emissions, technology requirements keep going up, and companies that can’t keep up, merge, close their doors and go out of business or move to another product. Twenty years ago, there may have been twenty piston ring companies globally. That number has now been reduced to six as a result of rising quality and technology requirements. Because China’s local market is large—and growing— those same companies would live to fight another day if they were in China. They would compete against companies that have similar issues, and some would improve their quality and technology and move up to the foreign/local market, but all of them would grow. In China, no matter how low the quality and technology of your product, you can sell it somewhere if it’s cheap enough. This why China tends to have so many more companies in each product category—a growing local market gives them a lifeline.
The fourth conclusion is that the existence of the large local market puts downward pressure on pricing. I realize that every company thinks that their home market is very cost conscious, but I would argue that the China market is by far the most cost conscious in the world.
Finally, this all leads to innovation. The old adage that the Chinese can copy but they can’t create is going by the wayside. Every day, 1.3 billion Chinese wake up and try to figure out how to make what they use in their daily life cheaper and more convenient. China’s entrepreneurs need to innovate to solve problems and take advantage of opportunities with solutions that meet the affordability constraints of the marketplace.
Doug: As a foreign executive, it’s important that I know about and understand the local market, but how important is it that I compete in that market?
Jack: It depends very much on the product. With many products, I would argue that it’s virtually impossible for a foreign company to get to the price points needed to compete with the locals. A friend of mine, Mr. Dong Yang, a senior Chinese executive who was on the board of one of our companies, once told me that people who wear shoes shouldn’t fight with people who wear sandals.
There is a certain amount of truth to that, but, as you point out, it’s important that foreign executives and companies at least pay attention to, and understand, the local market. For one thing, it is where their future competition is likely to come from. As we discussed before, companies get to fight another day in China, and as they are fighting, they can get larger because the local market keeps growing as the overall economy grows. Some of them, not all of them, will improve their quality and technology and move up to the foreign/local market. Once they get there, guess where they’re headed? Overseas. I’ve been in China for twenty-five years, and I’ve never met a Chinese CEO that doesn’t want to be global. China just isn’t a big enough sandbox for them.
Over the next twenty to twenty-five years, you are going to see company after company, with names you can’t pronounce, move from the local market to the foreign/local market in China, and then make the jump to the overseas markets.
Now, I’ll give you two examples of foreigners who have successfully penetrated the local market. The first is my old friend, Mitch Presnick, who came to China even before me, and brought the Super 8 budget hotel chain to China. Mitch was born in Brooklyn and first came to China in 1988. He learned Mandarin in Taiwan and worked in public relations, ultimately becoming the China manager for a public relations firm that advised companies like Anheuser-Busch on their China public relations strategies.
In 2001, Mitch became interested in China’s economy hotel market, the roughly 80 percent of China’s approximately ten thousand starred hotels that are designated two or three star and where the quality is suspect. Foreign-run hotels, which are typically designated with four or five stars and have superior management, account for approximately one-third of the industry’s multibillions of revenues—even though there are only about a thousand of them. Mitch’s idea was to bring a brand, better management, and an international reservation system to the local market for economy hotels.
Mitch decided to target Super 8, because as you know, “8” is a lucky number in China. He got on a plane and flew to New Jersey where the company that owned the rights to the Super 8 franchise was located, and asked for the rights to China. It still blows my mind that as early as 2001, the company gave it to him. If he had gone in and asked for the rights to Portugal, I’m sure they would have said that they would give him Lisbon and then see how he made out. But, China was so far removed from what they would do, that they just went ahead and gave him the whole country!
With the Super 8 franchise in hand, Mitch and some friends successfully put together a chain with hundreds of low cost hotels across the country, targeting room rates in the 150-yuan range. I don’t know how many Super 8’s there are here now, but the company has been quite successful and has now received venture funding. Mitch and Super 8 are an example of a foreigner and a foreign brand that came to China and successfully competed in the low price, two and three star hotel business.
Another good friend of mine, Eric Costantino, was the French founder and owner of ERIC Paris hair salons in China. (Many find it funny that one of my best friends in China is a French hair dresser.) Before coming to China in 1996, Eric owned one of the largest private chains of salons in the south of France. His salons in Beijing and Shanghai were at the upper end of the market in China, and they’ve become the salons of choice for China’s celebrities, actresses, models, and up-and-comers. On any given Saturday, Eric’s salons in Beijing and Shanghai were the places to be where the “who’s who” of the fashion and entertainment industry in China would gather to have their hair done. Needless to say, a haircut at Eric’s was what you would pay in New York or Paris.
While Eric’s traditional salons were high priced and catered to China’s rich and famous, Eric saw enormous potential in the local market for hair and beauty. Working with Carrefour, a large French retailer with hundreds of stores across China, Eric entered into a deal to locate low priced shops in all of Carrefour’s stores. This fit with Carrefour’s plan to make its stores into destinations, where the husband and wife could shop, go to the beauty shop and get their car washed or repaired—all in one convenient location. Eric picked “Salon 88” (another good name) as the name for his shops, and offered woman’s haircuts starting at 28 yuan, or about $4, to the local market.
Eric and his Salon 88 shops are another good example of a foreigner successfully competing in the local market, demonstrating that it is possible for a foreigner or a foreign company to penetrate this segment. It’s not easy, but it is possible.
In this podcast, Jack and Doug Perkowski discuss how China’s lower cost perspective, in combination with the way in which the country has developed economically over the past 40 years, has created two markets in the country—a purely local market that is characterized by low price and low technology and a foreign/local market that is characterized by high price and high technology. If you want to sell your products in China, this podcast is a must.
***
Excerpt: “The China market is very fragmented. In any product that has a certain amount of technology, there are perhaps a half dozen companies around the word that make the same product. Yet, when you come to China, there are 500, 700 or 1000 companies making that product. The reason is the existence of the large, and growing local market.” Listen or read on to find out more.
***
Jack: In our podcast about the different—and lower—cost perspective that exists in China, I mentioned that China’s lower cost perspective, in combination with the way in which the country has developed over the past forty years, has created a market for most products, which is now the largest market in the world, but which operates much differently than the other large market in the world—the market in the United States.
For example, you might wonder why a product with any level of technology might has a half dozen companies around the world making that product, yet, when you come to China, there might be 500 or 1000 companies making the same product, or one that is functionally similar. A few examples. While the global auto industry has consolidated from 30,000 to no more than 10,000 suppliers over the years, upwards of 6,000 Chinese companies apply every year to display their products at the Beijing or Shanghai auto show. There are over 80 million private companies in China. There are literally hundreds of thousands of auto repair shops in the country, and millions of restaurants.
What gives rise to this phenomenon? To understand how China’s markets have developed, you need to go back to an earlier point in time when the market was much simpler. Let’s go back to 1988, and ask ourselves what the market for any product looked like at that time.
If I asked you to describe the China market in 1988, you’d tell me that you need more information. In 1988, China’s GDP was about $300 billion, and the country had a billion people. Therefore, the average per capita income was about $300, obviously not very high. I wasn’t in China in 1988, but, given these facts, I think that I can safely describe what the market for any product looked like at that time.
While China opened up to the outside world ten years earlier in 1978, and a number of companies from Hong Kong and Taiwan had set up factories in China’s Special Economic Zones, by and large, most of the products being made in China were made at purely local factories in 1988. While China had begun to export products by 1988, most of the products made by Chinese factories were still being purchased by local companies and consumers. In other words, in 1988, China was a completely local market from both a production and a consumption point of view, where the products being produced and sold were at the low end in terms of price and technology. Why at the low end? Well, per capita income was only $300, and I think you would agree that you can’t buy much with that amount of money.
Now, let’s fast forward to 2018. Last year, China’s GDP was about $12.2 trillion, a big, big increase from 1988; and China had about 1.3 billion people. Therefore, per capita income was over $8,500. But when you look at China, you need to consider that different segments of China’s population have vastly different income levels. For example, of China’s 1.3 population, there are about 300 million people that live in the countryside work in the country’s agricultural sector, and about 300 million migrant workers. All those beautiful buildings that you see in Beijing and Shanghai were built by migrant workers from the country’s villages who typically leave home to work for a few years, but then go back to their villages and hometowns in the countryside.
If you do the numbers, the average per capita income for those 600 million people is about $4,500, a lot different than the national average of about $8,500. Well, you might say, there are another 700 million people, where did they go? They moved up—and they formed a completely new market which I call the foreign/local market, where the average per capita income is much higher at about $14,500. Why do I call it the foreign/local market? I call it that because, when foreign companies come to China, this is the market they focus on. In terms of price, quality and technology, the products sold in the foreign/local market look a lot like the products that are sold in their home markets.
So, China’s 1.3 billion population is divided roughly between 700 million people who live in the cities and have much higher per capita incomes, and 600 million people who live in the countryside and have per capita incomes that are much lower than the national average. Admittedly, an average per capita income of $4,500 in the local market is much higher than the $300 in 1988, but it is still not high enough to buy products with the highest technology and quality. Therefore, products in this purely local market have to be cheap and affordable.
Summing it all up, the China market actually consists of two markets—a foreign/local market that is characterized by high price and high technology, and a purely local market that is characterized by low price and low technology. In the foreign/local market, foreign companies compete with other foreign companies and the best of the local Chinese companies, while the local market is virtually all local companies. The interesting fact about the local market is that it keeps growing. As China’s economy grew from $300 billion in 1988 to $12.2 trillion in 2017, the foreign/local market got established and grew, but the local market also grew larger.
Doug: Can you give me an example of an industry where this concept of China’s Two Markets has played out?
Jack: When I first started thinking about how China’s markets worked, the industry that hit me as being a good example is the restaurant industry.
Several years ago, my younger daughter, Libby, came to visit and it happened that her birthday fell during her trip, giving us the rare opportunity to celebrate in person. With Libby in town, we booked a table at the Courtyard, one of our favorite restaurants in Beijing—you’ve been there, Doug. The Courtyard’s setting couldn’t be any more spectacular. It’s located just opposite the East Gate of the Forbidden City, and it was one of the first upscale, Western, stand-alone restaurants to be built in Beijing. In addition to having a spectacular view and very nice interior furnishings, the food at the Courtyard is excellent. Rey Lim, the chef, worked at Bouley in New York and is a good friend.
Anyway, we had a fantastic meal, and Libby told me afterward that she considers the Courtyard to be
one of her favorite restaurants in the world, not just in Beijing. Prices at the Courtyard, naturally, are also what you’d expect to pay at a fine restaurant in New York, Paris or any other major international city. With a nice bottle of wine, the bill at that time came to about $100 per person. The Courtyard and restaurants like it are a good example of what I call the foreign/local market—high price, but also high quality and high technology in terms of food.
Right about that time, a good friend of ours came to Beijing with his wife, and we decided to take him to a good local restaurant. We took them to a restaurant that you know well, Doug, a local dumpling restaurant near the office that everyone loved. Before we went, we asked Henry Huang from our company, who we call our CFO—our Chief Food Officer, to write out an order. Henry knows food and he knows that restaurant well.
For six people, Henry ordered five plates of dumplings: fried dumplings, dumplings stuffed with pork and cabbage, pork and coriander dumplings, tomato and egg dumplings, and dumplings stuffed with pork and beans. He also included two cold dishes as starters, as well as a tomato and egg dish, an eggplant dish, and a spicy bean dish to eat with the dumplings. To wash it all down, we ordered five Diet Cokes and one bottle of water. Each plate contained about fifteen dumplings, so we had more than enough to eat.
As we waited for the check, we played the traditional “How much will the bill be?” game. Obviously it was a lot of food, and the food was fantastic, so our friend’s first guess was in the area of 500 yuan. Of course, we had to tell him that his guess was way too high. As it turned out, the bill came to about 137 yuan, barely $3.00 a person! The dumpling restaurant is an example of what I call the local market. There are literally millions of restaurants like it in China where you can get a great deal of food at a cheap and affordable price.
A couple of days later, while our friends and Libby were still in town, another friend of ours, who happened to run the Hilton hotel in Beijing, was taking a group of people to the Li Qun Roast Duck restaurant. Everyone who has been to Beijing has, of course, had Beijing Duck, and Li Qun is one of the best duck restaurants in the city. It’s very famous restaurant, and when you walk in, the entry is lined with pictures of ambassadors and other important people who’ve eaten there over the years. It’s an example of a high end Chinese Restaurant.
There were twelve of us that ended up at Li Qun, and we had another great meal. We ordered three ducks, a spicy pork dish, plates of broccoli and eggplant, and two orders of fried duck bones, which is a specialty. Along with our meal, we had five large bottles of Yanjing beer. For twelve people, our bill came to 647 yuan, or about $8 per person.
So, these three restaurants illustrate perfectly what I say about China’s two markets—$3, $8, $100 for the price of a meal. The dumpling restaurant is an example of the purely local market. Low price, and good food, but simple in terms of the technology of food. In the foreign/local market, there is the Courtyard, but then there are also the Li Qun’s of the world, which are purely local restaurants that also compete in the foreign/local market. Li Qun is not as high priced as Courtyard, but, like the Courtyard, it serves a broad market, including foreigners and locals, and is higher priced than restaurants like the dumpling restaurants that cater primarily to the local market.
Doug: The restaurant industry is a bit specific. Certainly, there is a range of prices in China that is unmatched. But, you mentioned technology. How about an industry where technology is a factor?
Jack: Let’s take electric vehicles (“EVs”). In 2017, China produced 770,000 electric vehicles and led the world in this important category. But, that’s not the whole story, because every year, over 1.3 million low speed EVs are sold in China’s lower tier cities. What are low speed EVs? Basically, they are EVs that are limited to 80 kilometers per hour in terms of speed, and are not allowed on certain roads such as major expressways.
The way this market developed is very interesting, and is another illustration of China’s two markets.
Just like in the United States, the average EV passenger car costs $35,000 or more in China, and certainly, higher income consumers in the Beijing’s and Shanghai’s of the world can afford them. The EVs that fall into the 770,000 category are every bit as technologically developed as the EVs you would find in the United States or Europe. However, if you travel to the countryside and China’s lower tier cities, you will see whole families on a motorcycle—the mother, the father, the child and a bag of groceries. And, if it rains a lot in that province, they will have an umbrella attached. That family cannot afford $35,000 for an EV, but they can afford $5,000. And, they don’t need to go fast or go far. They only need to get to the other side of town.
Meanwhile, the leaders in these provinces would like to have their citizens to have safer and more convenient transportation, but they don’t want hundreds of thousands of cars powered by internal combustion engines adding to pollution. Over the past five or six years, an entirely new industry has grown up and over 100 companies, many in Shandong Province where this has all started, have invested billions of dollars to build low speed EVs that use conventional—and much cheaper—- lead acid batteries. Low speed EVs sell for about $5,000.
Once again, this is an example of China’s two markets at work. China’s overall EV industry consists of a foreign/local market, with 770,000 conventional EVs that have prices and technology levels exactly comparable to what you would find in the United States and Europe, and a much larger, purely local market, with more than 1.3 million low speed EVs being produced and sold each year. While low speed EVs have a much lower level of technology than conventional EVs, they meet the affordability requirements of the local market.
Doug: if I’m an executive looking to get into China, what conclusions can I draw from the existence of the two markets in China?
Jack: The first conclusion is that as big as you thought the China market is, it’s even bigger. If someone asks about the size of China’s EV market, you might say 770,000 units a year. But, I would say it’s actually much larger—it’s already more than two million vehicles.
The second conclusion is that the market is fast growing—China’s GDP grew from $300 billion to $12.2 trillion in thirty years. All industries, and both the foreign/local and the local markets, have grown larger as a result.
The third is that the China market is very fragmented. In any product that has a certain amount of technology, there are perhaps a half dozen companies around the word that make the same product. Yet, when you come to China, there are 500, 700 or 1000 companies making that product. The reason is the existence of the large, and growing local market.
Take ASIMCO’s piston ring business as an example. This is the same factory where they built a nice twenty story hotel that I talked about in our podcast on China’s Different Cost Perspective. Every year, the factory makes about 40 million piston rings a year, which makes it one of the largest in China, and one of the largest in the world.
A number of years ago, we did a market study, and found that our factory and our two largest competitors accounted for about 60% of the market. Yet, there were 180 companies in China making piston rings. Five years later, when we repeated the study, we found that there were more than 400 companies in the market place. You would think that with the need for consolidation, the number of companies would have gone down, not up, particularly in view of the fact that there are only a handful of serious piston ring manufacturers in the rest of the world.
The answer is simple. Because piston rings are essential to controlling emissions, technology requirements keep going up, and companies that can’t keep up, merge, close their doors and go out of business or move to another product. Twenty years ago, there may have been twenty piston ring companies globally. That number has now been reduced to six as a result of rising quality and technology requirements. Because China’s local market is large—and growing— those same companies would live to fight another day if they were in China. They would compete against companies that have similar issues, and some would improve their quality and technology and move up to the foreign/local market, but all of them would grow. In China, no matter how low the quality and technology of your product, you can sell it somewhere if it’s cheap enough. This why China tends to have so many more companies in each product category—a growing local market gives them a lifeline.
The fourth conclusion is that the existence of the large local market puts downward pressure on pricing. I realize that every company thinks that their home market is very cost conscious, but I would argue that the China market is by far the most cost conscious in the world.
Finally, this all leads to innovation. The old adage that the Chinese can copy but they can’t create is going by the wayside. Every day, 1.3 billion Chinese wake up and try to figure out how to make what they use in their daily life cheaper and more convenient. China’s entrepreneurs need to innovate to solve problems and take advantage of opportunities with solutions that meet the affordability constraints of the marketplace.
Doug: As a foreign executive, it’s important that I know about and understand the local market, but how important is it that I compete in that market?
Jack: It depends very much on the product. With many products, I would argue that it’s virtually impossible for a foreign company to get to the price points needed to compete with the locals. A friend of mine, Mr. Dong Yang, a senior Chinese executive who was on the board of one of our companies, once told me that people who wear shoes shouldn’t fight with people who wear sandals.
There is a certain amount of truth to that, but, as you point out, it’s important that foreign executives and companies at least pay attention to, and understand, the local market. For one thing, it is where their future competition is likely to come from. As we discussed before, companies get to fight another day in China, and as they are fighting, they can get larger because the local market keeps growing as the overall economy grows. Some of them, not all of them, will improve their quality and technology and move up to the foreign/local market. Once they get there, guess where they’re headed? Overseas. I’ve been in China for twenty-five years, and I’ve never met a Chinese CEO that doesn’t want to be global. China just isn’t a big enough sandbox for them.
Over the next twenty to twenty-five years, you are going to see company after company, with names you can’t pronounce, move from the local market to the foreign/local market in China, and then make the jump to the overseas markets.
Now, I’ll give you two examples of foreigners who have successfully penetrated the local market. The first is my old friend, Mitch Presnick, who came to China even before me, and brought the Super 8 budget hotel chain to China. Mitch was born in Brooklyn and first came to China in 1988. He learned Mandarin in Taiwan and worked in public relations, ultimately becoming the China manager for a public relations firm that advised companies like Anheuser-Busch on their China public relations strategies.
In 2001, Mitch became interested in China’s economy hotel market, the roughly 80 percent of China’s approximately ten thousand starred hotels that are designated two or three star and where the quality is suspect. Foreign-run hotels, which are typically designated with four or five stars and have superior management, account for approximately one-third of the industry’s multibillions of revenues—even though there are only about a thousand of them. Mitch’s idea was to bring a brand, better management, and an international reservation system to the local market for economy hotels.
Mitch decided to target Super 8, because as you know, “8” is a lucky number in China. He got on a plane and flew to New Jersey where the company that owned the rights to the Super 8 franchise was located, and asked for the rights to China. It still blows my mind that as early as 2001, the company gave it to him. If he had gone in and asked for the rights to Portugal, I’m sure they would have said that they would give him Lisbon and then see how he made out. But, China was so far removed from what they would do, that they just went ahead and gave him the whole country!
With the Super 8 franchise in hand, Mitch and some friends successfully put together a chain with hundreds of low cost hotels across the country, targeting room rates in the 150-yuan range. I don’t know how many Super 8’s there are here now, but the company has been quite successful and has now received venture funding. Mitch and Super 8 are an example of a foreigner and a foreign brand that came to China and successfully competed in the low price, two and three star hotel business.
Another good friend of mine, Eric Costantino, was the French founder and owner of ERIC Paris hair salons in China. (Many find it funny that one of my best friends in China is a French hair dresser.) Before coming to China in 1996, Eric owned one of the largest private chains of salons in the south of France. His salons in Beijing and Shanghai were at the upper end of the market in China, and they’ve become the salons of choice for China’s celebrities, actresses, models, and up-and-comers. On any given Saturday, Eric’s salons in Beijing and Shanghai were the places to be where the “who’s who” of the fashion and entertainment industry in China would gather to have their hair done. Needless to say, a haircut at Eric’s was what you would pay in New York or Paris.
While Eric’s traditional salons were high priced and catered to China’s rich and famous, Eric saw enormous potential in the local market for hair and beauty. Working with Carrefour, a large French retailer with hundreds of stores across China, Eric entered into a deal to locate low priced shops in all of Carrefour’s stores. This fit with Carrefour’s plan to make its stores into destinations, where the husband and wife could shop, go to the beauty shop and get their car washed or repaired—all in one convenient location. Eric picked “Salon 88” (another good name) as the name for his shops, and offered woman’s haircuts starting at 28 yuan, or about $4, to the local market.
Eric and his Salon 88 shops are another good example of a foreigner successfully competing in the local market, demonstrating that it is possible for a foreigner or a foreign company to penetrate this segment. It’s not easy, but it is possible.
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