China's foreign-owned supermarket giants reveal growth problems

With the recent closure of four Tesco outlets and rumors about Carrefour's exit from China, the strategy of making an emerging market a global retailer's growth engine becomes debatable.

As one of the world's three largest retailers, Tesco's success can be mainly attributed to channel and product diversification, a strong private label or own brand, its loyalty program and expansion overseas. Although Britain remains its most important market in terms of the number of stores and profitability, Tesco is increasingly looking to emerging markets to drive future growth.

In the first quarter of 2012, sales across Tesco's global operations rose 9.5 percent at actual exchange rates, of which sales in Asia grew 10.5 percent to $18.1 billion (14 billion euros). The Asian market seems to have become Tesco's growth engine.

However, with a slowing economy, and a combination of persistent high inflation and wage cost pressures, the Chinese market has become a tricky one.

Similar to earlier entrants such as Carrefour and Wal-Mart, Tesco operates a multi-format strategy in China. Hypermarkets continue to account for the vast majority of sales, although convenience stores are becoming more established in major cities such as Shanghai.

However, the development of foreign retailers' stores is unevenly distributed in China. The fragmented market is a double-edged sword. On the one hand, their profits are mainly driven by new stores, which provide room for growth. On the other hand, many local retailers already dominate in the provinces, and there are limited opportunities for opening new stores.

The three biggest foreign retailers have struggled in China over the years. Carrefour entered China in 1995, followed by Wal-Mart in 1996, before the market liberalization in November 2004. Both of them experienced government policy constraints before China joined the World Trade Organization in 2001. Tesco entered after the market became freer but lost the advantage gained by the two early entrants.

Tesco entered China by acquiring Hymall, which it gained control of in 2006. However, the integration of Tesco and Hymall did not go as smoothly as expected, and the double-brand strategy has not generated sufficient benefits after 12 years of integration.

Carrefour and Wal-Mart entered China by joint ventures with local companies, as required by the country's policies, and this helped them to understand the market and government policies, and adapt to the host country. Wal-Mart adopted the practice of listing or slotting fees to further cooperate with suppliers. Carrefour restructured its strategy and launched city commission units to consolidate its decision-making powers at its headquarters. Tesco invested its efforts in loyalty programs and leveraged its success in South Korea.

However, the retailers' development slowed down in 2009 during the global financial crisis, and the opening of new stores dramatically decreased.

While China is set to continue as one of the most rapidly growing markets for most foreign retailers, the key locations for big stores in the major cities of China have been taken by early entrants and by local retailers. The regions in the west and tier-two and tier-three cities are not suitable for big stores.

Smaller store units may be a good choice in some cities, but the market capacity is not as big as those in major cities. Foreign retailers will have to face supply chain challenges if their stores are far from their distribution centers. Acquisition might be a solution, like that of Baolongcang by Carrefour in Hebei province in 2010.

Private or own-brand labeling by retailers is considered another way of increasing profits. All foreign entrants have promised to increase investment in private labels in China, which gives them leverage when bargaining with suppliers, but few have done this. This may be in part due to the local practice of listing fees - where suppliers pay for their products to be stocked and positioned - which accounts for a big slice of the profits. Retailers, therefore, have to deal carefully with their suppliers.

Foreign retailers have vast experience in promoting their own labels and a strong brand image, but store space is limited for both private and other branded products purchased from their suppliers, and the balance is hard to manage.

Human resources in China throw up other problems. There is a high mobility of skilled personnel, as well as a lack of local experts to handle the supply chain challenges of a highly fragmented market and who have solid marketing expertise to adapt to different purchasing behaviors in far-off regions.

Meanwhile, domestic retailers are enjoying the spillover in staff from foreign competitors. In the merger of Wal-Mart and Trust-Mart, a Taiwan-based retailer, many senior and middle managers joined local retailers.

However, this does not mean to say that Tesco has placed itself in an awkward position in China. The restructure of its management team and the closure of some under performing outlets in China are consistent with the retailer's long-term strategy.

Besides, its two main foreign competitors also suffered setbacks. Wal-Mart China expanded its number of outlets by acquiring Trust-Mart but has been suffering from the integration until now. The Carrefour pricing scandal in 2008 and the Wal-Mart mis-labeled pork scandal in Chongqing in 2011 damaged the superstores' reputations.

Other foreign entrants are smaller in terms of number of stores, except current market leader RT-Mart, which had an initial public offering with French retailer Auchan on the Hong Kong Stock Exchange in 2010.

The fragmented nature of China's market provides an opportunity for foreign entrants' multi-outlet strategy, including online stores. Convenience stores and smaller supermarkets, rather than hypermarkets, are also a promising prospect, and strong local retailers that have gained market share in tier-two and tier-three cities are potential acquisition targets for foreign retailers.

The author is a PhD student at Emlyon Business School, France. He will be a lecturer in strategy at ESC Rennes School of Business, France. The views do not necessarily reflect those of China Daily.

(China Daily 09/28/2012 page9)