Our recent trips to China have highlighted emerging Chinese consumer trends and their impact on Chinese corporations. We continue to see evidence of the economic shift toward consumption and services. The sheer abundance of companies in these new areas is staggering—including new entertainment companies, pharmaceutical firms and travel start-ups. And these are often not listed in Hong Kong.
Consumers have evidently developed more quickly than companies have been able to adapt to fulfill their new needs. Supply-side reform is not just about cutting capacity in industrial areas. It is also about creating capacity in areas that are not currently serviced, but where there is overwhelming demand. The sheer quantity of online cross-border purchases highlights the supply deficit within China.
The causes of this lack of supply are twofold; firstly consumer companies overseas have underestimated the pent up power of the Chinese consumer and are now struggling to catch up. Foreign companies are well aware of the high costs of executing branding and distribution in a country so vast and heavily populated. The second reason for supply deficiency is the speed with which the Chinese consumer has evolved, and the inability of domestic corporations to adapt to this change.
A Missing Piece: Branding
What we are witnessing is a broad rollout of strategies that involve outsourced manufacturers, referred to as OEMs (original equipment manufacturers), attempting to develop a domestic brand either organically or by overseas acquisition. Domestically developed brand power in China is immature, and very often a brand exists today not because of extensive brand-building investment, but because the company has found a gap in the consumer market that is not being serviced. The strategy of OEMs attempting to develop brands is not new but it has become exponentially more aggressive. Among companies we recently visited, we identified a variety of gaps between supply and demand. These impact a wide array of consumer products and services—custom wardrobes, young men’s fashion, children’s car seats, low priced SUV, cinemas, live sports entertainment, and the list goes on.
With the forceful growth in demand for consumer products and services comes the inevitable supply, and there is no barrier to supply in China. Today, national distribution in China is easily achievable given the country’s vast investments in IT and physical infrastructure. What we are seeing today are many new companies with new brands or distribution models with no management track record, where the only real barrier to entry is economies of scale. This new world of the Chinese consumer company is making stock picking exciting but ever more challenging, and necessitating bottom-up analysis. Although these developments present many compelling opportunities, buyers of new Chinese consumer corporates beware—there are bound to be hitches along the way as firms navigate the road to China’s new consumer-driven economy.
Andrew Mattock, CFA
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