Beyond Beijing: Selling Across China

The Mainland's second-tier cities offer lower ad costs, cheaper rents, better labor, and customers with money in their pockets

by Shaun Rein

Recent studies have shown that more than 50% of foreign multinationals expect to make money by selling to Chinese consumers by the end of 2007. This is a dramatic shift from just a few years ago when 70% of companies lost money in the Middle Kingdom—not true of players such as Wal-Mart (WMT) and General Electric (GE), which leveraged low labor costs to produce in China for export.

The turnaround in the China fortunes for these companies has been fueled by a consumer revolution in first-tier cities such as Shanghai, Beijing, and Guangzhou where the disposable income of the 15 million people in the middle classes has reached over $4,000 a year.

Most of China's 300,000 millionaires live in these urban centers and increasingly buy luxury goods from producers such as PPR, owner of the Gucci Group, and Louis Vuitton. The numbers are not insignificant. For instance, China is Rolls Royce's third largest market after the U.S. and Britain. It is the world's fifth largest market for cosmetics and seventh for retail sales.

Money in the Smaller Cities

Naturally, most multinationals have focused on selling to consumers in glitzy metropolises like Shanghai where hulking skyscrapers punctuate the skyline. However, many overseas companies are making a mistake by targeting just these consumers and neglecting China's less developed cities.

Savvy companies understand that Chinese consumers in second- and third-tier cities such as Chengdu, Wuhan, and Chongqing will be the engine for growth in the coming decade. Some 50 million residents live in these three cities—more than the entire populations of Canada and Australia combined—and they have average disposable incomes that are increasing 15% a year and reached $1,550 in 2006.

Cars, Not Tourists

Consumers in these less-developed cities crave international goods such as Nokia (NOK) mobile phones, Hewlett Packard (HPQ) computers, or Estée Lauder (EL) cosmetics. They want to demonstrate their newfound wealth and express themselves.

An executive from L'Oréal (LRLCY) recently told me that their fastest sales in China are coming from Guizhou, a city in a province that's the least visited by foreign tourists in all of China. Daimler Chrysler's (DCX) Maybach 62 and Ferrari's F430 sold out in Harbin when they were first introduced.

These are three reasons why multinationals should target consumers in less-developed urban centers in China.

Squeezed Margins

Real estate prices have skyrocketed in Shanghai and Beijing over the past five years. Despite government efforts to rein in speculative investment from overseas, Shanghai's commercial rents increased 16% in Pudong and 13% in Puxi year-on-year in the second quarter of 2006 alone.

Rising rents have squeezed margins for restaurants and retail chains and leave little profit even if revenue numbers are growing. Business-to-business companies have had to grapple with spiraling rents, too, and have often relocated to areas farther away from main business areas.

In Wuhan, retailers can buy downtown business space for $3,250 per square meter as opposed to $4,500 in Beijing or $6,800 in Shanghai. Similarly, it costs 15 times as much to advertise in Shanghai than in Chengdu on TV, according to AdAgeChina. Print-media advertising prices show a similar disparity.