McKinsey partner Yuval Atsmon analyzes the siting and pros and cons of foreign brands' development during China's urbanization process. Provided to China Daily

Big or small, all of China's cities are growing - but how and where to locate a new business is a major challenge

"Location, location, location", the mantra of homebuyers and sellers, is equally paramount when it comes to setting up shop - and is especially so as China's urbanization drive continues to present retailers with various opportunities for expansion and development.

Over the years, many foreign companies have taken advantage of China's urbanization, such as General Motors, which formed a joint venture with China's SAIC and rapidly expanded to include hundreds of dealerships in many of China's smaller cities.

Another US major fast-food chain, KFC, developed warehouses and supply chains to create scale at regional and national level. It also creatively structured its expansion into smaller cities, carefully planning and sometimes taking years to select the right locations for outlets, according to Yuval Atsmon, a partner at the international consultancy McKinsey.

"The best retailers take a lot of time to study bus routes, train routes and where roads are built," says Atsmon, a former head of McKinsey's Greater China consumer retail practice.

"Choosing locations is easy in the US, because people typically travel by car and urban development is slow. But in Chinese cities, the exact location of where you put your stores makes a huge difference."

Atsmon also says the rising level of consumption-related infrastructure in cities is bringing urban residents increasingly diverse and affordable products.

"Modern retail resulting from urbanization can operate at higher efficiency, and such efficiency, as well as increasing competition, is making products cheaper for consumers," he says.

"Take supermarkets and hypermarkets for example. Chinese cities' rapidly growing amount of roads and railways has made it economical and convenient for consumers to visit them, so they can stock a large amount of goods and reduce costs."

Wal-Mart and Carrefour have already opened hundreds of stores in China, with increasing penetration into China's third and fourth-tier cities, as these cities gradually increase in size.

"Global experience suggests that people want to buy at a store that is no more than 15 minutes' commute from their home, and prefer even closer locations for day-to-day items like fresh food," he says. "This creates market demand for more supermarkets to open in urban areas, where population is more concentrated.

"Because many urban residents have cars, they can drive to supermarkets and hypermarkets for their shopping. But rural areas would have less demand for supermarkets that typically stock 15,000 items, because the lack of efficient transport means people would buy from small shops locally."

Atsmon says there are also products that can only be offered with an urban infrastructure, such as cold-chain items.

"You cannot buy ice-cream without cold chain. The same goes for frozen food and even chocolates in hot regions," he says. "Another example is automotives, which you can only deal in where there are good roads, which come as a result of urbanization."

Another driver of increasing consumption is the rise in average income as an economy urbanizes.

"If I'm quite poor, I'm more likely to focus on necessities, including clothing, diapers and baby food, and basic electronics like a refrigerator and washing machine," he says.

"These items are relatively basic, but their consumption increases in urban areas where people can find these goods more easily and at better prices, and start to consume them more regularly."

As people's income grows, they can afford extra consumer items on top of the basic ones, and sectors like luxury goods, travel services, communications, cars, skincare products and restaurants would see even faster growth, he says.

Also, urbanization increases the speed of communication and interaction, and this encourages consumption through a network effect as people's buying decisions influence those of friends.

As China's consumers become increasingly sophisticated in demanding better products, they prefer to buy more premium or innovative products.

In China's toothpaste market, Atsmon notes, US manufacturer Procter & Gamble developed Crest more than 10 years ago as a quality line for Chinese consumers.

It offered a green tea-flavored version, and kept prices low through basic packaging and other means, he says. But over time, as Chinese consumers became wealthier, they looked for more, and brands such as Colgate have grown market share with more premium versions.

Atsmon says that although foreign brands are increasingly eyeing opportunities in the Chinese market, they are facing increasing competition from local competitors.

"I think 10 to 15 years ago there was a big difference between foreign and local brands on, for example, expertise on how to open fast-food restaurant chains.

"Now, some foreign players may still have a scale advantage, but the knowledge is also available to Chinese players."

Pepsi and Coca-Cola used to have the advantage of management expertise, but China's beverage companies, such as giant Wahaha, are catching up.

In other sectors, Atsmon adds, Chinese consumer brands, such as the household appliances company Haier and technology firm Lenovo, are leading their markets in China. Some are even leading sales globally.

He says these brands have the advantage of extensive distribution networks and the ability to take full advantage of urbanization, even in the smaller Chinese cities.

"Sometimes it's harder for foreign brands that are less flexible in the cost model to come in," he says. "But new opportunities still exist for everyone."

Atsmon believes that as China's urban centers mature, it will be more difficult for new foreign consumer brands to enter, as they would face tough competition from both foreign and Chinese brands that entered the market early.

Such early entrants, like KFC, have established themselves well in major urban centers and are now shifting their focus to smaller cities. Atsmon says those brands that are first to move into smaller cities will benefit most as consumption increases.

"In bigger cities, it is very difficult to pay for advertising, real estate, people, so you can be more profitable in small cities," he says. "But in smaller cities, the challenge of getting talent is bigger. There is always the risk you train the talent and a competitor takes them away from you."

However, he believes it is not a good idea for foreign brands to directly enter smaller cities without going into bigger ones first, even if profit margins in bigger cities are quickly falling.

"Big cities gives you scale, they give you reputation and allow you to afford to spend on things like media investment," Atsmon claims.

One solution is to set up the cluster model, he suggests, where more investment into bigger cities achieves economy of scale, and helps a company expand into surrounding smaller cities. Operations in the main cities would focus on training and setting up distribution centers.

This model of investment would be more efficient than investing in different cities across diverse parts of China, he says.

cecily.liu@chinadaily.com.cn

( China Daily European Weekly 07/26/2013 page26)