And the Bottles Are Open:
And the Bottles Are Open: An Introduction to China’s Soft Drink Market
Jiahua Che1 School of Business Hong Kong University of Science and Technology
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This report was made possible thanks to the support from rabobank international.
Table of Contents
1. Introduction 2. Product Categorization 3. A Brief History 4. The Value Chain 5. Buyers: Characteristics of Demand for Soft Drinks in China 6. The Supply Side 7. Concluding Remarks
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Introduction China is a fast expanding market for soft drinks. Over the 1998-2003 period, the Chinese soft drinks market as a whole experienced volume growth of over 124%, and it is forecast to continue its strong growth, albeit at a slower rate of 80%, between 2003 and 2008. The overall market is far from being saturated yet. China’s per capita consumption of soft drinks is estimated at 15 liters in 2002, about 30% of world average (53 liters) and only 4% of the United States average (358 liters) (Exhibit 1). As the Chinese economy booms and disposable income increases across all regions, soft drink industry will have a bright future, especially for healthy drinks such as fruit/vegetable juice, ready-to-drink (RTD) tea and bottled water. Exhibit 1. GDP per capita v.s soft drinks consumption per capita (China 2002, other countries 2001)
Product Categorization There are different categorizations for soft drink products. In this report, we focus on four groups of products: carbonated drinks, ready-to-drink (RTD) tea, bottled water, and fruit juice/fruit drink. As of 2002, carbonated drink contributed about 31% of
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China soft drink output, bottled water 37%, RTD tea 12% and fruit juice 7%.2
A Brief History In the beginning of 1980s, drinking beverages were still a luxury for most Chinese. Soft drinks, which consisted of carbonated drinks almost exclusively, were purchased only during major holidays and festivities, and glass bottles were the only packaging for soft drinks. In 19982, soft brink became a listed item in the state planning. Since then, the soft drink industry has grown at an average pace of 21% annually. Within a short span of 20 some years, China’s soft drink market went through three stages of development. The first stage was in the 1980s, which saw the emergence of carbonated drinks. Major soft drink giants, such as Coca Cola and Pepsi (re)entered China in 1979 and 1981 respectively. Coca Cola was the first American consumer product company to return to China after the normalization of diplomatic relations between China and U.S.. And with a market share of 80%, the carbonated drinks dominated Chinese soft drink market for the decade of 1980s. 1990s witnessed the second stage of soft drink industry development, where bottled water overtook carbonated drinks and became the industry leader with about 40% market share. By the end of last century, ready-to-drink tea dominated the industry growth, marking the beginning of the third stage. Bottled tea held a market share of 12% and an annual growth of 85%, with its output more than quadrupled between 1999 and 2002. Analysts predicted that juice and milk drinks would become the catalyst for growth in the next phase of development.3
The Value Chain The upper stream firms of soft drink industry consist of packaging suppliers and raw material suppliers (such as sugar, sweeteners, and so on). Different packaging materials, including cans, plastic bottles, glass, and paper packaging, are used in the soft drink industry to suit different logistic, sale, and storage needs of different drinks. In China, glass bottles made of 30% of soft drink packaging, plastic 30%, metal cans 20%, and paper packaging 10%. The main manufacturers in soft drink industry involve concentrate producers and bottlers. Concentrate producers blend necessary raw material ingredients and ship the blended ingredients to bottlers, who add additional ingredients and bottle or can the soft drink, and deliver it to customer accounts wherever possible. The process of making 2 3
2003 China Industry Development Report: Beverage, p 85. “Soft Drinks in China”, Euromonitor International.
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concentrate involves little capital investment in machinery, overhead, or labor. In the United States, a typical concentrate manufacturing plant costs approximately $25 million to build (as of 1995) and one plant could serve a country the size of the United States. The bottling process, on the other hand, can be capital-intensive and involves specialized, high speed lines. Lines are interchangeable only for packages of similar size and construction. Bottling lines in the United States cost from $4 million to $10 million for one line, depending on volume and package type. It costs at least $20 million to $30 million to build a small bottling plant (with warehouse and office space) in the United States (as of 1995).4 To reach consumers, soft drink makers use various distribution channels. When it is feasible, bottlers will typically directly distribute products to their customers. In areas where direct distribution cannot cover, bottlers will reply on outside distributors/wholesalers. Whether distributing directly or indirectly, final consumers are reached through retail outlets. In China, typical retail outlets for soft drinks include supermarkets, convenience stores, food retailers such as restraints, ice cream shops and roadside stalls, and vending (see Exhibit 3). Exhibit 2. The value chain of soft drink products
Exhibit 3. Distribution split across retail and food services
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“Internationalizing the Cola Wars” Harvard Business School Case, No. 9-795-186.
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Buyers: Characteristics of Demand for Soft Drinks in China As suggested earlier, China’s per capita consumption of soft drinks is still at 30 percent of world average. However, because consumption infrastructure is particularly lagging behind in rural China, where personal income level is also lower, most of the beverage drinking in China is concentrated in urban areas. It is estimated that over 80% of Chinese soft drink consumption takes place in urban China. Even if we assume all the soft drinks were consumed by the urban population, their per capita consumption would still only be an estimated 40 liters, which is less than 80% of world average. Even though Asians seem to drink less soft drink as compared to people in other parts of the world (see Exhibit 1), the anticipated rising income will surely stimulate China’s overall demand for soft drinks.
1. Market Segments It is important to realize the economic diversity in China when it comes to consumer goods like soft drinks. And the differences are multi-dimensional, and these dimensions are not completely orthogonal to each other. One dimension is the urbanrural divide. It is pointed out earlier that about 80% of soft drink in China takes place in urban areas. Rural China is hard, if not impossible, to penetrate deeply for the soft drink industry, partly because of the lack of infrastructure concerning distribution/ logistics and retailing. On the other hand, China is fast urbanizing itself, either through turning towns to cities through improved economic conditions and infrastructure, or through rural-tourban migration. Exhibit 3 demonstrates the rapid acceleration of urbanization in China. Exhibit 4. Acceleration in Chinese urbanization
Another dimension of difference is income, which often coincides with income differences. In fact, in today’s China, urban areas represent 43% of the total population 6
but 58% of total disposable income. Even among urban areas, income varies from regions to regions. One can take a peek at the pattern of regional income differences through the next exhibit. This unbalanced economic development means that purchasing power in China differs across regions and hence requires different strategies to tackle each different market. Exhibit 5. Income difference between urban and rural China and among major cities
A recent A.T. Kearney report divided the Chinese fast-moving-consumer-goods market in urban areas into 4 segments, based upon income, population, impact on surrounding areas, and degree of market openness. Tier 1 cities consist of 2% of all Chinese cities, 2% of the entire population, but contribute to 13% of China’s GDP and the total disposal income of these cities accounts for about 8% at the national level. According to A.T. Kearney, global and national brands have already tightened their grip on the tire 1 market. Tier 2 market host primarily national brands. It has 7% of the population and accounts for 7% of all cities. It contributes 19% to the GDP, but its share of disposable income is at the 12% only. Tier 3 and tier 4 markets still remain open to global and national brands, but carries currently mainly regional and local products. Tier 3 has 12% of the total population, accounting for about 19% of all cities. Its share of disposable income is at 16% whereas its share of GDP is 25%. 72% of Chinese cities fall into the last tier. Together they contribute 22% to the entire Chinese population, but only 16% of the GDP, while its share of disposable income is 42%. These last two tiers of
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markets have proved difficult to penetrate for multinationals as the underdeveloped distribution infrastructure and fragmented retail markets remain too great a challenge. A third dimension is based on consumers’ age and gender profile. Market researches show that the target customers for soft drinks were people in the 11 to 40 age group. Compared to other age groups, young consumers are more concerned with brand, lifestyle and fashion, and are easy targets for new products; whereas older consumers care more about health, nutrition, and the functional benefits of the drink. Women and children prefer sweeter drinks; men and young consumers care more for a crisp taste; and older consumers desire a light taste. In general, Chinese customers fancy so-called “modern” products, and as a result, products branded and packaged with Western names and images would be considered “better”, especially among the nou·veaux riches. However, a more recent trend of Chinese consumers’ preferences is their nationalist sentiment and many soft drink producers have seized this trend and try to market their products as “patriotic” brands. 2. Lifecycle of Soft Drinks Categories Over the recent years, different soft drink products have demonstrated quite different growth trends. After years of dominance in the soft drinks market, carbonated drinks finally gave way to bottled waters, which recorded a growth of 20% in 2002 as compared to 12% of carbonated drinks. During the same year, RTD tea grew by 17%. In contrast, the growth of juice and fruit juice was most remarkable at 46% (see Exhibit 6) Judging from the growth rate patterns of each soft drinks category, industry analysts believe that carbonated drinks appears to be a mature category while bottled water is entering the mature phase. RTD tea drinks are approaching the later stages of growth, while juice and juice drinks are entering a phase of explosive growth from what is a very low base.5 Note that, by maturing, it is meant that the income elasticity of demand decreases from an explosively high level to some more “normal” level (as illustrated by Exhibit 1). Also note that the previous assessments apply to urban China only. In rural China, however, all soft drink categories are still at a very early stage (see Exhibit 7).
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Rabobank International: “China Soft Drinks Industry Review: The race to meet consumer needs”. 8
Exhibit 6. Changes in the product structure of China’s soft drink industry (1999-2002) (10,000 tons) 1000
750
500
250
0 1999
2000
carbonated drinks
2001
bottled waters
RTD tea drinks
2002 juice and juice drinks
Source: 2003 China Industry Development Report: beverage
Exhibit 7 Product Lifecycle in China
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3. SARS and Health Consciousness There has been increased health awareness following the SARS outbreak in 2002. Analysts expect that increasing health consciousness, together with rising living standards and “modern” lifestyle brought in from developed countries, will in the urban areas drive a growth in demand for products in the direction of being natural, functional, fat-free, low-calorie, sugar-free, fortified with vitamins, minerals and other healthy elements.6 4. Branding versus Distribution Like all fast-moving-consumer products, soft drink products can be marketed to consumers through either pull or push strategies, that is, either through active marketing to arose consumers’ interests or through aggressive distribution efforts to deliver products to as many customer accounts as possible. Recent years have seen a shift in marketing strategies in the soft drink industry. According to a study by Richard Ivey School of Business at the University of Western Ontario, prior to 1997, the marketing emphasis was on brand-building and companies had invested heavily on advertising, despite the fact that there is typically fairly low brand-loyalty in this industry.7 Since 1997, either because major brands already dominated a sector (such as in the carbonated drink sector) or as many brands proliferated in a sector and several companies taking similar positioning (such as in the case of fruit juice sector), distribution had become a key battleground for gaining competitive advantage. As for affluent urban consumers, they are naturally less sensitive to prices given the fact that soft drinks are relatively inexpensive to their income. In fact, market surveys conducted in some major Chinese cities show that three most important choice criteria for the consumers are, in order, taste, brand, and price (with the exception of bottled water where consumers rate brand the most important, followed by price and taste). This ordering may be different when it comes to consumers with lower income. Part of the success of Future Cola of Wahaha in rural China was indeed attributed to its lower price as compared to Coke. Furthermore, such ordering of importance can be in constant changes as products continue to be marketed to different segments of consumers.
5. Threat of Substitutes and Channel Conflict Substitutes for soft drink products as a whole may be quite limited (except maybe tap water, but clean tap water in China is hardly available). However, different soft drink categories constitute competing alternatives for each other. On the other hand, the 6 7
Euromonitor International: “Soft Drinks in China”. “Internationalizing the Cola Wars” Harvard Business School Case, No. 9-795-186.
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manufacturing platforms (such as production lines for bottling) as well as marketing/distribution channels are oftentimes common to all these categories, it sometimes makes sense for a company to span its product line to cover different soft drink categories (see Exhibit 7). Nevertheless, because of different categories tend to compete with each other, a dominant leader in one category may be less willing to invest heavily into other categories unless different categories shown different growth promises (as in the case of carbonated drinks versus RTD tea and bottled water).
The Supply Side 1. Entry Barriers, Concentration, and Rivalry The soft drink industry is not heavily regulated by the government and is one that has become very open to foreign and domestic private investment. The industry has little technology barriers (technology barriers may however lie in its upstream – packaging material). Even though bottling is considered to be capital intensive, the amount of investment needed for a production line is said to be less than that in the United States, for example. It is estimated that one bottling line costs around 0.4 to 0.5 million Chinese Yuan.8 Carbonated Drink Thanks to the relatively low entry barriers, the industry, for the most part, has remained highly fragmented. There are over 800 soft drinks producers in China, but the level of concentration varies from sector to sector. The carbonated drink sector has rather high concentration. Together, Coca Cola and Pepsi dominate this sector with a market share of around 65% (Coca Cola 42% and Pepsi 23% in 2001). Under the competition from these two global giants, many domestic brands faded out from the market. The only successful story is Future Cola from Wahaha, which in 2001 took 14% of market share (the share of Wahaha in this category was 1% in 1998) by targeting the sale at rural areas, a market segment which has been neglected by Coca Cola and Pepsi because of difficulty in distribution.9 At the same time, the success of Wahaha in the rural market perhaps also illustrated the difficulty, if not impossibility, to crack into the stronghold of Coca Cola and Pepsi in urban areas, especially those top-tier markets. Bottled Water With the exception of carbonated drinks, all other sectors, from RTD tea drinks to bottled waters to juice and fruit juice drinks, are luring new entrants eager to grab their share of a growing market. In the bottled water sector, more than 200 companies are currently involved in the production. The dominant players in this sector 8
“Sales of tea drinks in China estimated at 5.5 million tons in 2003” China Foreign Trade, 2003.5.1. from China Info Bank. 9 The quoted data is from “Cola Wars in China: The Future Is Here”, Harvard Business School Case No. 903A06. 2003 China Industry Development Report documented Coca Cola’s market share at 44.3%, Pepsi 31.4%, and China’s national brands less than 25%. 11
are Wahaha, Nonfu Spring, and Robust, all of which are local companies and jointly hold about 58% of the market. However, Groupe Danone has controlling stakes in soft drink joint ventures with Wahaha and in Robust. Competition is fierce in this sector, especially as the demand of bottled water has become stifled in the top-tier markets. Outside toptier markets, the large distances from production sources to the points of consumption, making it costly and ineffectively to distribute packaged water. The overriding tactics used by the majority of bottled water operators has been aggressive pricing. Fierce competition has led to price cuts of over 50%, leaving half of them making losses. New entrants often gain market share through very low price points, which in turn makes it hard to remain the business in the medium to longer term. Nonetheless, cut-through competition has led to a more concentrated market structure. The top 10 players now control about 78% of the market share and the shrinkage of profits is dampening the interest of potential new entrants into the segment. RTD Tea The sector of RTD tea drink is highly profitable. It is estimated that RTD tea has an average cost of 1.2 Yuan but the retailing price is about 3 Yuan on average.10 The lucrative nature of the business attracted a lot of “new” entrants, many of them are not entirely new in the sense that a majority of them are existing soft drink makers with established brand names and distribution channels, but are leveraging on these existing assets to enter into the new territory of RTD tea. Two Taiwanese companies have now become the market leaders in this sector: Tingyi and Uni-president, each controlling 52% and 24% of market share respectively in 2002. These two companies have earned their success by leveraging their brand equity as well as their extensive distribution channels across China, established for their instant noodle business. A previous market leader Xuri group on the other hand has faded miserably on the tea drink market, and saw its market share dropping from 70-80% in late 1990s to a single digit by 2002. Fruit Juice Fruit juice and fruit drink sector is a rising star in the soft drink market. Although it accounts for only a small share in the entire soft drink market (about 10%), but is growing rapidly with an annual growth rate of 45% on average. It is also a sector that has the lowest concentration (see Exhibit 7), as the rapid growth of this sector attracting many entrants, large and small. According to Rabobank International, Tingyi ad Uni-President, each hold a market share of little over 20%.11 However, China Industry Development Report (2003) suggested that market share of the top 10 companies in the fruit juice and fruit drink is only about 20%. As in the case of bottled water, many companies resort to lower price points as their competitive strategies, with some products being priced as low as those of bottled water. Besides price competition, many companies have also resorted to product differentiation, targeting to different market segments and changing preferences of consumers, such as adding additional 10 11
2003 China Industry Development Report: Beverage. Rabobank International: “China Soft Drinks Industry Review: The race to meet consumer needs”.
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nutrients to drinks to attract increasingly health-conscious consumers and children in particular, or increasing fruit content to appeal to high-end customers. China’s soft drink market as a whole is dominated by Coca Cola, Pepsi, Tingyi, and Uni-President. However, recent years have seen Coca Cola’s market share beginning to decline gradually, along with Pepsi’s market share, even though Coca Cola continues to be the market leader. Rapid rising are the market shares of Tingyi and Uni-president. Yet in comparison with developed markets, the industry remains fragmented. In 2001, the combined output of the top 10 domestic soft drink producers in China accounted for just 40% of the national total. Exhibit 8. Major soft drink players in China
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Exhibit 9. Consolidation level, growth, and per capita consumption (2002)
2. Bargaining Power of Upstream Firms Soft drink companies rely on firms in the packaging industry to supply packaging materials, which include paper, plastic, metal can, and glass, and the packaging typically takes about 40% of the product cost. In China, 95% of bottled water and 70% of carbonated drinks use plastic packaging. The plastic packaging industry is capital intensive and has high entry barriers because of high capital and technological requirements, thus offering strong first mover advantages. Currently, the industry is dominated by two major companies Zhongfu and Zhijiang with about 60% market share together and 30-40% and 20% respectively; both companies are highly competitive. While the two companies are said to have high profit margin as a result of large scale economies, plastic packaging industry itself has a weak bargaining position with its own suppliers, i.e., oil companies. Different soft drink producers seem to form quite different relationships with the upstream industry. New comers, such as Wahaha and Robust, have their own in-house plastic packaging production line; large established firms such as Coca Cola, Pepsi Cola, and Uni-President source their bottles from Zhongfu and Zijiang. Paper packaging is also important to soft drink industry. As compared to plastic, paper packaging has the advantage of low cost, light weight, more suitable for logistic purposes; however, it has the disadvantage of not being able to well hermetically sealed
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and sterilized by heat. China’s paper packaging sector is dominated by Swedish company Tetra Pack, which is said to control 95% of market share (although Tetra Pack itself disputes the figure). 12 Glass packaging has been increasingly replaced by other means of packaging, especially plastic bottling, and over recent years the use of glass packaging in soft drinks, especially in the segment of fruit drinks, has been in constant decline. Metal can packaging is currently in the state of excessive supply. China’s metal can packaging industry still faces the challenge of improving technology, reducing costs, and enhance product quality.13 Domestically manufactured metal cans have the problem of leakage and opener being easily broken. In order to consider the bargaining power of upstream firms, it is also important to take into account that different packaging materials have different physical and chemical properties and hence best suit for different soft drink products under different logistic conditions, especially when it comes to lower tier markets which are typically some distance away from bottling plants. 3. Bargaining Power of Downstream Firms: the Distribution Challenge The key downstream firms in the soft drink industry consist of distributors, wholesalers, and retailers. To reach final consumers, soft drink makers rely on these firms as intermediaries to push their products. Thus it is important to understand some of the basic characteristics of China’s distribution sector. Back in the 1980s, the distribution sector was still dominated by China’s stateowned wholesale and retail system. The traditional system was formed in the socialist model and was designed to allocate resources deep into every corner of Chinese society. It was an extensive system, characterized by multi-layers, normally three tiers in most of the provinces (and four or five tiers for larger provinces). The state-owned wholesalers distribute products for each industry from the entire country to province and cities, then to local retailers. Large department stores sometimes also act as wholesalers to local retailers. State-owned wholesalers had very little incentives to push products into the market, and they were very inefficient and backward in inventory management and after sale services. Another important characteristics of this wholesale and retail system is that it coincided with the planning hierarchy, which meant that it was organized both along the product lines (broadly characterized, for instance, there were wholesalers/retailers specialized in dealing with watches and clocks, and those specialized in clothing) as well as along administrative lines. Nevertheless, this multi-layer distribution system is pertinent to market environments of China. The vast territory and dispersed population in
12 13
“Foreign firms monopolize China’s sterilized packaging in milk and fruit drink industry”, Market News, 2004.1.6. “The current status of China’s beverage packaging industry”, China Food News, 2003.10.6.
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the rural areas require goods to be distributed in small scale and long distance. Intermediaries can help reduce the transportation costs b grouping and sorting products. Exhibit 10. The Wholesale Channel Structure in China
As the economic reform began to unfold in China, so did the liberalization of the Chinese distribution sector. Over years, the distribution saw a large scale entry of smallsize enterprises specialized both in wholesaling and perhaps more in retailing. Meanwhile, enterprises within the traditional state wholesale/retail system become privatized. This wave of liberalization on the one hand created a vibrant sector with strong profit motives to expand and push products, and yet at the same, turned the original state wholesale/retail network into a highly fragmented jungle. Furthermore, as many wholesale/retail enterprises were traditionally organized along administrative lines, their operations are heavily influenced by local politics, making it possible for local governments to enact regional barriers to stifle competition in efforts to protect local business. In recent years, the government has sought to encourage the emergence of modern trade channels such as supermarkets, chain-stores, and convenience stores. During the past few years, sales in these new retail formats have grown more than 50% annually. Nevertheless, this modern trade still accounts for less than 30% of retail sales in China and it serves only one-quarter of the 500 million urban consumers. Most consumers, who have reached threshold spending levels of many soft drink products, continue to shop at mom-and-pop markets and small, local department stores, making traditional trade
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channels remain a significant part of the economy. And this phenomenon is likely to continue for at least a decade.14 Meanwhile, as part of China’s commitments to WTO, China will open the distribution sector for foreign participation. Of all the commitments China made when it became a WTO member, this was one of the most eagerly anticipated by foreign multinationals. Subsidiaries of foreign companies in China will be permitted to engage in wholesaling, retailing, and franchising, as well as distribution support services such as warehousing, inventory management, delivery, after-sales services, and repair and maintenance. Majority foreign ownership of most type of distribution business becomes permissible. Existing limits on geographic location of numbers of foreign-invested distribution enterprises will also be lifted. In the early 1980s when soft drink makers, such as Coca Cola and Pepsi, first entered the market, they had little choice but to rely on state wholesale/retail system in order to reach consumers on a large scale, given the fact that initial market might have not been dense enough to justify direct distribution for all their customer accounts. A 1997 Harvard Business case estimated that approximately 15% of these two soft drink giants’ products were distributed directly, with the rest going through the state wholesale/retail system. Overtime, as the Chinese soft drink market becomes “thicker”, some of the soft drink makers become increasingly reliant upon their own direct distribution networks. These direct distribution channels, however, are deployed to serve traditional trade channels, as modern traditional channels are still at their early stage of development in China. The direct distribution provides the most assurance to soft drink manufactures, since they have full control of the sales force and selling activities. It allows the manufactures to quickly collect information from consumers and effectively design marketing campaign to push their products and control prices to avoid excessive competition. It also allows these companies to better coordinate different activities involved in the distribution. However, direct distribution is only cost effective for the soft drink makers with large volumes of sales in highly populated large Chinese cities. As markets become thinner outside these major cities, direct distribution becomes a less attractive proposition. In this case, soft drink manufactures often have to resort to indirect distribution channels, hiring the services of outside distributors including making use of the state wholesale/retail system. It is in this area that the transaction costs of pushing soft drink products to markets outside major Chinese cities rise quickly. In most developed economies, distributors are professional-services companies that assume selling and other value-added activities on behalf of the manufacturer. In China, however, most distributors are passive and have little experience in sales or service. The next 14
“Wholesale Distribution Changes for a Winning China Strategy,” Boston Consulting Group. March 2004.
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exhibit demonstrates some of the key contrasts between Chinese distributors and their Western counterparts. Exhibit 11 How Chinese Distributors Compare with Their Western Counterparts
Moreover, because the distribution sector is underdeveloped, agency costs are typically very high. In some cases, outside distributors may mix fake products with genuine soft drinks they are asked to market. In some cases, outside distributors do not follow soft drink manufacturers’ pricing and sales guideline and aggressively compete with other distributors that market the same products, destroying soft drink makers’ pricing structure. In other cases, outside distributors take orders from soft drink makers and make sales, but fail (either unable or unwilling) to pay soft drink makers, forcing the latter to pile up a huge amount of accounts receivables. Defection by distributors from one soft drink maker to another is commonly observed as well. Sometimes, competition among distributors turn so ugly, they even resort to violence. Distribution outside major markets is made difficult also because of China’s underdeveloped logistic networks. The next exhibit compares the surface transportation network coverage of China with that of some other countries. It shows that the infrastructure development in China lags behind not only major developed countries, but also some comparable developing economies such as Brazil and India. In recent years, the central government has devoted a considerable amount of resources in improving
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China’s infrastructure, especially in the coastal areas. The ratio of infrastructure investment in traffic/transportation and communications to the total basic construction investment increased from 10% in 1990 to about 27% in 2000. About 80% was spent in investments related to traffic and transportation. Development activities are also being expended inland from the coast areas under the developing the west campaign. Exhibit 12 Surface Transportation Infrastructure of China as Compared to Selected Countries 228464 6406296
France 32175 894000
Germany 46039 230735
Japan 23705 1161894
Russia 87157 532393
Brazil 29412 1724929
India 63140 3319644
0.0073
0.0237
0.0588
0.1289
0.0627
0.0051
0.0035
0.0192
0.146
0.665
1.634
0.646
3.075
0.031
0.203
1.010
Railways/po p*10000
0.539
7.796
5.324
5.585
1.862
6.0617
1.5976
0.593
highways/p op*10000
0.108
2.186
1.480
0.280
0.912
0.370
0.937
0.312
Railways highways Railways/sq km highways/s qkm
China 70058 1402698
U.S.
Concluding Remarks The potential of China’s soft drink market has yet to be fully tapped and is poised to continue to grow rapidly in the immediately future, even though growth will slow down slightly from the torrid pace a few years ago. The product structure is likely to evolve rapidly, as income growth, changing preferences, shifting consumer profiles, and competitive pressures among soft drink makers will change people’s demand for different varieties of soft drink. New product development is essential in the more maturing segments. Eventually, the growth must also be supported by tapping into markets outside major cities, where challenges in distribution in particular lie ahead.
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Jiahua Che1 School of Business Hong Kong University of Science and Technology
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This report was made possible thanks to the support from rabobank international.
Table of Contents
1. Introduction 2. Product Categorization 3. A Brief History 4. The Value Chain 5. Buyers: Characteristics of Demand for Soft Drinks in China 6. The Supply Side 7. Concluding Remarks
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Introduction China is a fast expanding market for soft drinks. Over the 1998-2003 period, the Chinese soft drinks market as a whole experienced volume growth of over 124%, and it is forecast to continue its strong growth, albeit at a slower rate of 80%, between 2003 and 2008. The overall market is far from being saturated yet. China’s per capita consumption of soft drinks is estimated at 15 liters in 2002, about 30% of world average (53 liters) and only 4% of the United States average (358 liters) (Exhibit 1). As the Chinese economy booms and disposable income increases across all regions, soft drink industry will have a bright future, especially for healthy drinks such as fruit/vegetable juice, ready-to-drink (RTD) tea and bottled water. Exhibit 1. GDP per capita v.s soft drinks consumption per capita (China 2002, other countries 2001)
Product Categorization There are different categorizations for soft drink products. In this report, we focus on four groups of products: carbonated drinks, ready-to-drink (RTD) tea, bottled water, and fruit juice/fruit drink. As of 2002, carbonated drink contributed about 31% of
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China soft drink output, bottled water 37%, RTD tea 12% and fruit juice 7%.2
A Brief History In the beginning of 1980s, drinking beverages were still a luxury for most Chinese. Soft drinks, which consisted of carbonated drinks almost exclusively, were purchased only during major holidays and festivities, and glass bottles were the only packaging for soft drinks. In 19982, soft brink became a listed item in the state planning. Since then, the soft drink industry has grown at an average pace of 21% annually. Within a short span of 20 some years, China’s soft drink market went through three stages of development. The first stage was in the 1980s, which saw the emergence of carbonated drinks. Major soft drink giants, such as Coca Cola and Pepsi (re)entered China in 1979 and 1981 respectively. Coca Cola was the first American consumer product company to return to China after the normalization of diplomatic relations between China and U.S.. And with a market share of 80%, the carbonated drinks dominated Chinese soft drink market for the decade of 1980s. 1990s witnessed the second stage of soft drink industry development, where bottled water overtook carbonated drinks and became the industry leader with about 40% market share. By the end of last century, ready-to-drink tea dominated the industry growth, marking the beginning of the third stage. Bottled tea held a market share of 12% and an annual growth of 85%, with its output more than quadrupled between 1999 and 2002. Analysts predicted that juice and milk drinks would become the catalyst for growth in the next phase of development.3
The Value Chain The upper stream firms of soft drink industry consist of packaging suppliers and raw material suppliers (such as sugar, sweeteners, and so on). Different packaging materials, including cans, plastic bottles, glass, and paper packaging, are used in the soft drink industry to suit different logistic, sale, and storage needs of different drinks. In China, glass bottles made of 30% of soft drink packaging, plastic 30%, metal cans 20%, and paper packaging 10%. The main manufacturers in soft drink industry involve concentrate producers and bottlers. Concentrate producers blend necessary raw material ingredients and ship the blended ingredients to bottlers, who add additional ingredients and bottle or can the soft drink, and deliver it to customer accounts wherever possible. The process of making 2 3
2003 China Industry Development Report: Beverage, p 85. “Soft Drinks in China”, Euromonitor International.
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concentrate involves little capital investment in machinery, overhead, or labor. In the United States, a typical concentrate manufacturing plant costs approximately $25 million to build (as of 1995) and one plant could serve a country the size of the United States. The bottling process, on the other hand, can be capital-intensive and involves specialized, high speed lines. Lines are interchangeable only for packages of similar size and construction. Bottling lines in the United States cost from $4 million to $10 million for one line, depending on volume and package type. It costs at least $20 million to $30 million to build a small bottling plant (with warehouse and office space) in the United States (as of 1995).4 To reach consumers, soft drink makers use various distribution channels. When it is feasible, bottlers will typically directly distribute products to their customers. In areas where direct distribution cannot cover, bottlers will reply on outside distributors/wholesalers. Whether distributing directly or indirectly, final consumers are reached through retail outlets. In China, typical retail outlets for soft drinks include supermarkets, convenience stores, food retailers such as restraints, ice cream shops and roadside stalls, and vending (see Exhibit 3). Exhibit 2. The value chain of soft drink products
Exhibit 3. Distribution split across retail and food services
4
“Internationalizing the Cola Wars” Harvard Business School Case, No. 9-795-186.
5
Buyers: Characteristics of Demand for Soft Drinks in China As suggested earlier, China’s per capita consumption of soft drinks is still at 30 percent of world average. However, because consumption infrastructure is particularly lagging behind in rural China, where personal income level is also lower, most of the beverage drinking in China is concentrated in urban areas. It is estimated that over 80% of Chinese soft drink consumption takes place in urban China. Even if we assume all the soft drinks were consumed by the urban population, their per capita consumption would still only be an estimated 40 liters, which is less than 80% of world average. Even though Asians seem to drink less soft drink as compared to people in other parts of the world (see Exhibit 1), the anticipated rising income will surely stimulate China’s overall demand for soft drinks.
1. Market Segments It is important to realize the economic diversity in China when it comes to consumer goods like soft drinks. And the differences are multi-dimensional, and these dimensions are not completely orthogonal to each other. One dimension is the urbanrural divide. It is pointed out earlier that about 80% of soft drink in China takes place in urban areas. Rural China is hard, if not impossible, to penetrate deeply for the soft drink industry, partly because of the lack of infrastructure concerning distribution/ logistics and retailing. On the other hand, China is fast urbanizing itself, either through turning towns to cities through improved economic conditions and infrastructure, or through rural-tourban migration. Exhibit 3 demonstrates the rapid acceleration of urbanization in China. Exhibit 4. Acceleration in Chinese urbanization
Another dimension of difference is income, which often coincides with income differences. In fact, in today’s China, urban areas represent 43% of the total population 6
but 58% of total disposable income. Even among urban areas, income varies from regions to regions. One can take a peek at the pattern of regional income differences through the next exhibit. This unbalanced economic development means that purchasing power in China differs across regions and hence requires different strategies to tackle each different market. Exhibit 5. Income difference between urban and rural China and among major cities
A recent A.T. Kearney report divided the Chinese fast-moving-consumer-goods market in urban areas into 4 segments, based upon income, population, impact on surrounding areas, and degree of market openness. Tier 1 cities consist of 2% of all Chinese cities, 2% of the entire population, but contribute to 13% of China’s GDP and the total disposal income of these cities accounts for about 8% at the national level. According to A.T. Kearney, global and national brands have already tightened their grip on the tire 1 market. Tier 2 market host primarily national brands. It has 7% of the population and accounts for 7% of all cities. It contributes 19% to the GDP, but its share of disposable income is at the 12% only. Tier 3 and tier 4 markets still remain open to global and national brands, but carries currently mainly regional and local products. Tier 3 has 12% of the total population, accounting for about 19% of all cities. Its share of disposable income is at 16% whereas its share of GDP is 25%. 72% of Chinese cities fall into the last tier. Together they contribute 22% to the entire Chinese population, but only 16% of the GDP, while its share of disposable income is 42%. These last two tiers of
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markets have proved difficult to penetrate for multinationals as the underdeveloped distribution infrastructure and fragmented retail markets remain too great a challenge. A third dimension is based on consumers’ age and gender profile. Market researches show that the target customers for soft drinks were people in the 11 to 40 age group. Compared to other age groups, young consumers are more concerned with brand, lifestyle and fashion, and are easy targets for new products; whereas older consumers care more about health, nutrition, and the functional benefits of the drink. Women and children prefer sweeter drinks; men and young consumers care more for a crisp taste; and older consumers desire a light taste. In general, Chinese customers fancy so-called “modern” products, and as a result, products branded and packaged with Western names and images would be considered “better”, especially among the nou·veaux riches. However, a more recent trend of Chinese consumers’ preferences is their nationalist sentiment and many soft drink producers have seized this trend and try to market their products as “patriotic” brands. 2. Lifecycle of Soft Drinks Categories Over the recent years, different soft drink products have demonstrated quite different growth trends. After years of dominance in the soft drinks market, carbonated drinks finally gave way to bottled waters, which recorded a growth of 20% in 2002 as compared to 12% of carbonated drinks. During the same year, RTD tea grew by 17%. In contrast, the growth of juice and fruit juice was most remarkable at 46% (see Exhibit 6) Judging from the growth rate patterns of each soft drinks category, industry analysts believe that carbonated drinks appears to be a mature category while bottled water is entering the mature phase. RTD tea drinks are approaching the later stages of growth, while juice and juice drinks are entering a phase of explosive growth from what is a very low base.5 Note that, by maturing, it is meant that the income elasticity of demand decreases from an explosively high level to some more “normal” level (as illustrated by Exhibit 1). Also note that the previous assessments apply to urban China only. In rural China, however, all soft drink categories are still at a very early stage (see Exhibit 7).
5
Rabobank International: “China Soft Drinks Industry Review: The race to meet consumer needs”. 8
Exhibit 6. Changes in the product structure of China’s soft drink industry (1999-2002) (10,000 tons) 1000
750
500
250
0 1999
2000
carbonated drinks
2001
bottled waters
RTD tea drinks
2002 juice and juice drinks
Source: 2003 China Industry Development Report: beverage
Exhibit 7 Product Lifecycle in China
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3. SARS and Health Consciousness There has been increased health awareness following the SARS outbreak in 2002. Analysts expect that increasing health consciousness, together with rising living standards and “modern” lifestyle brought in from developed countries, will in the urban areas drive a growth in demand for products in the direction of being natural, functional, fat-free, low-calorie, sugar-free, fortified with vitamins, minerals and other healthy elements.6 4. Branding versus Distribution Like all fast-moving-consumer products, soft drink products can be marketed to consumers through either pull or push strategies, that is, either through active marketing to arose consumers’ interests or through aggressive distribution efforts to deliver products to as many customer accounts as possible. Recent years have seen a shift in marketing strategies in the soft drink industry. According to a study by Richard Ivey School of Business at the University of Western Ontario, prior to 1997, the marketing emphasis was on brand-building and companies had invested heavily on advertising, despite the fact that there is typically fairly low brand-loyalty in this industry.7 Since 1997, either because major brands already dominated a sector (such as in the carbonated drink sector) or as many brands proliferated in a sector and several companies taking similar positioning (such as in the case of fruit juice sector), distribution had become a key battleground for gaining competitive advantage. As for affluent urban consumers, they are naturally less sensitive to prices given the fact that soft drinks are relatively inexpensive to their income. In fact, market surveys conducted in some major Chinese cities show that three most important choice criteria for the consumers are, in order, taste, brand, and price (with the exception of bottled water where consumers rate brand the most important, followed by price and taste). This ordering may be different when it comes to consumers with lower income. Part of the success of Future Cola of Wahaha in rural China was indeed attributed to its lower price as compared to Coke. Furthermore, such ordering of importance can be in constant changes as products continue to be marketed to different segments of consumers.
5. Threat of Substitutes and Channel Conflict Substitutes for soft drink products as a whole may be quite limited (except maybe tap water, but clean tap water in China is hardly available). However, different soft drink categories constitute competing alternatives for each other. On the other hand, the 6 7
Euromonitor International: “Soft Drinks in China”. “Internationalizing the Cola Wars” Harvard Business School Case, No. 9-795-186.
10
manufacturing platforms (such as production lines for bottling) as well as marketing/distribution channels are oftentimes common to all these categories, it sometimes makes sense for a company to span its product line to cover different soft drink categories (see Exhibit 7). Nevertheless, because of different categories tend to compete with each other, a dominant leader in one category may be less willing to invest heavily into other categories unless different categories shown different growth promises (as in the case of carbonated drinks versus RTD tea and bottled water).
The Supply Side 1. Entry Barriers, Concentration, and Rivalry The soft drink industry is not heavily regulated by the government and is one that has become very open to foreign and domestic private investment. The industry has little technology barriers (technology barriers may however lie in its upstream – packaging material). Even though bottling is considered to be capital intensive, the amount of investment needed for a production line is said to be less than that in the United States, for example. It is estimated that one bottling line costs around 0.4 to 0.5 million Chinese Yuan.8 Carbonated Drink Thanks to the relatively low entry barriers, the industry, for the most part, has remained highly fragmented. There are over 800 soft drinks producers in China, but the level of concentration varies from sector to sector. The carbonated drink sector has rather high concentration. Together, Coca Cola and Pepsi dominate this sector with a market share of around 65% (Coca Cola 42% and Pepsi 23% in 2001). Under the competition from these two global giants, many domestic brands faded out from the market. The only successful story is Future Cola from Wahaha, which in 2001 took 14% of market share (the share of Wahaha in this category was 1% in 1998) by targeting the sale at rural areas, a market segment which has been neglected by Coca Cola and Pepsi because of difficulty in distribution.9 At the same time, the success of Wahaha in the rural market perhaps also illustrated the difficulty, if not impossibility, to crack into the stronghold of Coca Cola and Pepsi in urban areas, especially those top-tier markets. Bottled Water With the exception of carbonated drinks, all other sectors, from RTD tea drinks to bottled waters to juice and fruit juice drinks, are luring new entrants eager to grab their share of a growing market. In the bottled water sector, more than 200 companies are currently involved in the production. The dominant players in this sector 8
“Sales of tea drinks in China estimated at 5.5 million tons in 2003” China Foreign Trade, 2003.5.1. from China Info Bank. 9 The quoted data is from “Cola Wars in China: The Future Is Here”, Harvard Business School Case No. 903A06. 2003 China Industry Development Report documented Coca Cola’s market share at 44.3%, Pepsi 31.4%, and China’s national brands less than 25%. 11
are Wahaha, Nonfu Spring, and Robust, all of which are local companies and jointly hold about 58% of the market. However, Groupe Danone has controlling stakes in soft drink joint ventures with Wahaha and in Robust. Competition is fierce in this sector, especially as the demand of bottled water has become stifled in the top-tier markets. Outside toptier markets, the large distances from production sources to the points of consumption, making it costly and ineffectively to distribute packaged water. The overriding tactics used by the majority of bottled water operators has been aggressive pricing. Fierce competition has led to price cuts of over 50%, leaving half of them making losses. New entrants often gain market share through very low price points, which in turn makes it hard to remain the business in the medium to longer term. Nonetheless, cut-through competition has led to a more concentrated market structure. The top 10 players now control about 78% of the market share and the shrinkage of profits is dampening the interest of potential new entrants into the segment. RTD Tea The sector of RTD tea drink is highly profitable. It is estimated that RTD tea has an average cost of 1.2 Yuan but the retailing price is about 3 Yuan on average.10 The lucrative nature of the business attracted a lot of “new” entrants, many of them are not entirely new in the sense that a majority of them are existing soft drink makers with established brand names and distribution channels, but are leveraging on these existing assets to enter into the new territory of RTD tea. Two Taiwanese companies have now become the market leaders in this sector: Tingyi and Uni-president, each controlling 52% and 24% of market share respectively in 2002. These two companies have earned their success by leveraging their brand equity as well as their extensive distribution channels across China, established for their instant noodle business. A previous market leader Xuri group on the other hand has faded miserably on the tea drink market, and saw its market share dropping from 70-80% in late 1990s to a single digit by 2002. Fruit Juice Fruit juice and fruit drink sector is a rising star in the soft drink market. Although it accounts for only a small share in the entire soft drink market (about 10%), but is growing rapidly with an annual growth rate of 45% on average. It is also a sector that has the lowest concentration (see Exhibit 7), as the rapid growth of this sector attracting many entrants, large and small. According to Rabobank International, Tingyi ad Uni-President, each hold a market share of little over 20%.11 However, China Industry Development Report (2003) suggested that market share of the top 10 companies in the fruit juice and fruit drink is only about 20%. As in the case of bottled water, many companies resort to lower price points as their competitive strategies, with some products being priced as low as those of bottled water. Besides price competition, many companies have also resorted to product differentiation, targeting to different market segments and changing preferences of consumers, such as adding additional 10 11
2003 China Industry Development Report: Beverage. Rabobank International: “China Soft Drinks Industry Review: The race to meet consumer needs”.
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nutrients to drinks to attract increasingly health-conscious consumers and children in particular, or increasing fruit content to appeal to high-end customers. China’s soft drink market as a whole is dominated by Coca Cola, Pepsi, Tingyi, and Uni-President. However, recent years have seen Coca Cola’s market share beginning to decline gradually, along with Pepsi’s market share, even though Coca Cola continues to be the market leader. Rapid rising are the market shares of Tingyi and Uni-president. Yet in comparison with developed markets, the industry remains fragmented. In 2001, the combined output of the top 10 domestic soft drink producers in China accounted for just 40% of the national total. Exhibit 8. Major soft drink players in China
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Exhibit 9. Consolidation level, growth, and per capita consumption (2002)
2. Bargaining Power of Upstream Firms Soft drink companies rely on firms in the packaging industry to supply packaging materials, which include paper, plastic, metal can, and glass, and the packaging typically takes about 40% of the product cost. In China, 95% of bottled water and 70% of carbonated drinks use plastic packaging. The plastic packaging industry is capital intensive and has high entry barriers because of high capital and technological requirements, thus offering strong first mover advantages. Currently, the industry is dominated by two major companies Zhongfu and Zhijiang with about 60% market share together and 30-40% and 20% respectively; both companies are highly competitive. While the two companies are said to have high profit margin as a result of large scale economies, plastic packaging industry itself has a weak bargaining position with its own suppliers, i.e., oil companies. Different soft drink producers seem to form quite different relationships with the upstream industry. New comers, such as Wahaha and Robust, have their own in-house plastic packaging production line; large established firms such as Coca Cola, Pepsi Cola, and Uni-President source their bottles from Zhongfu and Zijiang. Paper packaging is also important to soft drink industry. As compared to plastic, paper packaging has the advantage of low cost, light weight, more suitable for logistic purposes; however, it has the disadvantage of not being able to well hermetically sealed
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and sterilized by heat. China’s paper packaging sector is dominated by Swedish company Tetra Pack, which is said to control 95% of market share (although Tetra Pack itself disputes the figure). 12 Glass packaging has been increasingly replaced by other means of packaging, especially plastic bottling, and over recent years the use of glass packaging in soft drinks, especially in the segment of fruit drinks, has been in constant decline. Metal can packaging is currently in the state of excessive supply. China’s metal can packaging industry still faces the challenge of improving technology, reducing costs, and enhance product quality.13 Domestically manufactured metal cans have the problem of leakage and opener being easily broken. In order to consider the bargaining power of upstream firms, it is also important to take into account that different packaging materials have different physical and chemical properties and hence best suit for different soft drink products under different logistic conditions, especially when it comes to lower tier markets which are typically some distance away from bottling plants. 3. Bargaining Power of Downstream Firms: the Distribution Challenge The key downstream firms in the soft drink industry consist of distributors, wholesalers, and retailers. To reach final consumers, soft drink makers rely on these firms as intermediaries to push their products. Thus it is important to understand some of the basic characteristics of China’s distribution sector. Back in the 1980s, the distribution sector was still dominated by China’s stateowned wholesale and retail system. The traditional system was formed in the socialist model and was designed to allocate resources deep into every corner of Chinese society. It was an extensive system, characterized by multi-layers, normally three tiers in most of the provinces (and four or five tiers for larger provinces). The state-owned wholesalers distribute products for each industry from the entire country to province and cities, then to local retailers. Large department stores sometimes also act as wholesalers to local retailers. State-owned wholesalers had very little incentives to push products into the market, and they were very inefficient and backward in inventory management and after sale services. Another important characteristics of this wholesale and retail system is that it coincided with the planning hierarchy, which meant that it was organized both along the product lines (broadly characterized, for instance, there were wholesalers/retailers specialized in dealing with watches and clocks, and those specialized in clothing) as well as along administrative lines. Nevertheless, this multi-layer distribution system is pertinent to market environments of China. The vast territory and dispersed population in
12 13
“Foreign firms monopolize China’s sterilized packaging in milk and fruit drink industry”, Market News, 2004.1.6. “The current status of China’s beverage packaging industry”, China Food News, 2003.10.6.
15
the rural areas require goods to be distributed in small scale and long distance. Intermediaries can help reduce the transportation costs b grouping and sorting products. Exhibit 10. The Wholesale Channel Structure in China
As the economic reform began to unfold in China, so did the liberalization of the Chinese distribution sector. Over years, the distribution saw a large scale entry of smallsize enterprises specialized both in wholesaling and perhaps more in retailing. Meanwhile, enterprises within the traditional state wholesale/retail system become privatized. This wave of liberalization on the one hand created a vibrant sector with strong profit motives to expand and push products, and yet at the same, turned the original state wholesale/retail network into a highly fragmented jungle. Furthermore, as many wholesale/retail enterprises were traditionally organized along administrative lines, their operations are heavily influenced by local politics, making it possible for local governments to enact regional barriers to stifle competition in efforts to protect local business. In recent years, the government has sought to encourage the emergence of modern trade channels such as supermarkets, chain-stores, and convenience stores. During the past few years, sales in these new retail formats have grown more than 50% annually. Nevertheless, this modern trade still accounts for less than 30% of retail sales in China and it serves only one-quarter of the 500 million urban consumers. Most consumers, who have reached threshold spending levels of many soft drink products, continue to shop at mom-and-pop markets and small, local department stores, making traditional trade
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channels remain a significant part of the economy. And this phenomenon is likely to continue for at least a decade.14 Meanwhile, as part of China’s commitments to WTO, China will open the distribution sector for foreign participation. Of all the commitments China made when it became a WTO member, this was one of the most eagerly anticipated by foreign multinationals. Subsidiaries of foreign companies in China will be permitted to engage in wholesaling, retailing, and franchising, as well as distribution support services such as warehousing, inventory management, delivery, after-sales services, and repair and maintenance. Majority foreign ownership of most type of distribution business becomes permissible. Existing limits on geographic location of numbers of foreign-invested distribution enterprises will also be lifted. In the early 1980s when soft drink makers, such as Coca Cola and Pepsi, first entered the market, they had little choice but to rely on state wholesale/retail system in order to reach consumers on a large scale, given the fact that initial market might have not been dense enough to justify direct distribution for all their customer accounts. A 1997 Harvard Business case estimated that approximately 15% of these two soft drink giants’ products were distributed directly, with the rest going through the state wholesale/retail system. Overtime, as the Chinese soft drink market becomes “thicker”, some of the soft drink makers become increasingly reliant upon their own direct distribution networks. These direct distribution channels, however, are deployed to serve traditional trade channels, as modern traditional channels are still at their early stage of development in China. The direct distribution provides the most assurance to soft drink manufactures, since they have full control of the sales force and selling activities. It allows the manufactures to quickly collect information from consumers and effectively design marketing campaign to push their products and control prices to avoid excessive competition. It also allows these companies to better coordinate different activities involved in the distribution. However, direct distribution is only cost effective for the soft drink makers with large volumes of sales in highly populated large Chinese cities. As markets become thinner outside these major cities, direct distribution becomes a less attractive proposition. In this case, soft drink manufactures often have to resort to indirect distribution channels, hiring the services of outside distributors including making use of the state wholesale/retail system. It is in this area that the transaction costs of pushing soft drink products to markets outside major Chinese cities rise quickly. In most developed economies, distributors are professional-services companies that assume selling and other value-added activities on behalf of the manufacturer. In China, however, most distributors are passive and have little experience in sales or service. The next 14
“Wholesale Distribution Changes for a Winning China Strategy,” Boston Consulting Group. March 2004.
17
exhibit demonstrates some of the key contrasts between Chinese distributors and their Western counterparts. Exhibit 11 How Chinese Distributors Compare with Their Western Counterparts
Moreover, because the distribution sector is underdeveloped, agency costs are typically very high. In some cases, outside distributors may mix fake products with genuine soft drinks they are asked to market. In some cases, outside distributors do not follow soft drink manufacturers’ pricing and sales guideline and aggressively compete with other distributors that market the same products, destroying soft drink makers’ pricing structure. In other cases, outside distributors take orders from soft drink makers and make sales, but fail (either unable or unwilling) to pay soft drink makers, forcing the latter to pile up a huge amount of accounts receivables. Defection by distributors from one soft drink maker to another is commonly observed as well. Sometimes, competition among distributors turn so ugly, they even resort to violence. Distribution outside major markets is made difficult also because of China’s underdeveloped logistic networks. The next exhibit compares the surface transportation network coverage of China with that of some other countries. It shows that the infrastructure development in China lags behind not only major developed countries, but also some comparable developing economies such as Brazil and India. In recent years, the central government has devoted a considerable amount of resources in improving
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China’s infrastructure, especially in the coastal areas. The ratio of infrastructure investment in traffic/transportation and communications to the total basic construction investment increased from 10% in 1990 to about 27% in 2000. About 80% was spent in investments related to traffic and transportation. Development activities are also being expended inland from the coast areas under the developing the west campaign. Exhibit 12 Surface Transportation Infrastructure of China as Compared to Selected Countries 228464 6406296
France 32175 894000
Germany 46039 230735
Japan 23705 1161894
Russia 87157 532393
Brazil 29412 1724929
India 63140 3319644
0.0073
0.0237
0.0588
0.1289
0.0627
0.0051
0.0035
0.0192
0.146
0.665
1.634
0.646
3.075
0.031
0.203
1.010
Railways/po p*10000
0.539
7.796
5.324
5.585
1.862
6.0617
1.5976
0.593
highways/p op*10000
0.108
2.186
1.480
0.280
0.912
0.370
0.937
0.312
Railways highways Railways/sq km highways/s qkm
China 70058 1402698
U.S.
Concluding Remarks The potential of China’s soft drink market has yet to be fully tapped and is poised to continue to grow rapidly in the immediately future, even though growth will slow down slightly from the torrid pace a few years ago. The product structure is likely to evolve rapidly, as income growth, changing preferences, shifting consumer profiles, and competitive pressures among soft drink makers will change people’s demand for different varieties of soft drink. New product development is essential in the more maturing segments. Eventually, the growth must also be supported by tapping into markets outside major cities, where challenges in distribution in particular lie ahead.
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