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Retail Internationalisation Strategies - Case Study Example

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The author of the paper titled "Retail Internationalisation Strategies" focuses on the global competition for retail customers in the fast-moving consumer goods (FMCG) sector in the People's Republic of China. It does not cover Hong Kong SAR or Macao SAR…
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Retail Internationalisation Strategies
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Running Head: RETAIL INTERNATIONALISATION STRATEGIES Retail Internationalisation Strategies of the of the Retail Internationalisation Strategies Introduction While the volume of academic research on retail internationalisation has increased dramatically, understanding of the process of retail internationalisation is still far from complete or comprehensive. Existing theories and analytical frameworks fail to capture or fully explain retail internationalisation as it is now happening (Dawson, 2001, 255). The search for a deeper understanding of the process of retail internationalisation is becoming more important as global retail concentration appears to be intensifying. The 1990s was an important decade for the development of international retailing. During this period there was a marked shift towards foreign direct investment and away from less intensive forms of internationalisation such as franchising (Myers, 1996, 25). In particular, there was a significant intensification of retail concentration in Europe driven by the merger and acquisition activities of powerful retailers, such as Carrefour, Ahold, Metro, Tesco and Wal-Mart. The opening up of the hitherto closed economies of Central and Eastern Europe and the Peoples Republic of China has helped to catalyse international competition between the major retailers. This paper focuses on the global competition for retail customers in the fast moving consumer goods (FMCG) sector in the Peoples Republic of China. It does not cover Hong Kong SAR or Macao SAR. The analysis is centred on two issues: the strategic importance of the Chinese market to international FMCG retailers and the long-term strategic objectives behind international expansion in China. The first section of the paper presents a brief review of the literature on the motivations behind retail internationalisation and an overview of the retail sector in China. Then follow the empirical results of our study. Finally an evaluation is provided of the likely effect of recent policy changes and Chinas accession to World Trade Organisation (WTO) membership on the retail sector. The Motives behind Retail Internationalisation It is widely recognised that retail internationalisation is initiated and influenced by the complex interplay of factors both exogenous and endogenous to retail firms. A number of motives behind retail internationalisation can be identified: growth-related motives: where internationalisation is a means to increased sales and profits through expansion into underdeveloped markets with high growth rates; domestic market maturity: saturation and concentration, increased competition, exhausted or unsuitable diversification prospects, surplus resources, depressed share prices, and/or a restrictive regulatory regime; motives derived from an internationally appealing and innovative retail concept; reactive and subjective motives: senior management drive, imitating competitors, responding to offers from foreign retailers, and responding to inducements from manufacturer-suppliers wishing to enter new markets; and motivations related to the transfer of retail know-how and techniques and/or economies of scale. The Retail Sector in the Peoples Republic of China The Peoples Republic of China (PRC) is the fastest growing large economy in the world. Many economic and social changes have been introduced since the ‘open-door’ policy was implemented in 1979. The annual average growth rate of GDP between 1978 and 1996 was about 10%. Since then, Chinas GDP growth rate has remained above 7%. By December 2001, GDP totalled more than US$1.15 trillion. Measured in terms of purchasing power parity, Chinas gross national income is the second largest in the world, just over half the size of the United States (World Bank, 2002). Total foreign direct investment (FDI) inflow between January and the end of September 2002 amounted to US$39.6 billion (China Daily, 13 November 2002). In terms of the retail sector, China has become a popular target for FDI since the partial opening of the retail sector to FDI in 1992. Although the affluent population only accounts for a small percentage of Chinas 1.2 billion inhabitants, the lure of so many potential customers seems irresistible to foreign investors. In the pantheon of anti-Communist elements, shopkeepers figured high up in the list. The retail and distribution sector was substantially neglected. Domestic retailers were fragmented and disorganised. However, from 1978 and the beginning of liberalisation, average urban disposable incomes started to increase, and more particularly, in the last decade. Indeed, faced with sluggish export markets since 2000, the government has been actively promoting domestic consumption so that today China presents tremendous opportunities to foreign retailers even though few possess extensive knowledge of the retail sector in China. International FMCG retailers that have established in China are listed in Table 1. In the retail and distribution sector, foreign retailers in anticipation of WTO membership have been expanding the number of outlets in China many without state permission, most notably Carrefour. Up to 2000, there were 29 state-approved retail joint ventures, with most of them originating from Asia and a few from Europe and North America (Euromonitor, 2000, 5). Wal-Mart has successfully opened seven super-centres, one of them, ‘Sams Club’, with a total investment close to RMB905 million (US$113 million); Carrefour has opened 33 chain stores in 15 Chinese cities and Metro has opened 15 cash and carry outlets. Furthermore, Metro has successfully signed an official investment agreement to set up the Metro Warehouse Management Company, which is the first wholly foreign-owned wholesaler in western China. International Retail Operations in China China cannot easily be treated as a single homogeneous market. Firstly, existing disparities of income between the coastal cities and those located in central and western China and between large cities and towns suggest that market potential varies widely between locations. Secondly, the exposure of the population in the south to foreign mass media, especially from Hong Kong, leads to differential buying behaviour between the south and the north (Yip, 1995, 253). To carry out the fieldwork for this research, four cities were chosen: Beijing and Shanghai were chosen as wealthy ‘northern’ cities and Guangzhou and Shenzhen as wealthy southern cities well within range of Hong Kongs mass media. All four cities are among those with the highest average urban per capita disposable income in China and have also been exposed to economic and political reform for longer than elsewhere. As a consequence, they are popular with foreign retailers for store locations. Twelve case studies were completed between April and September 1999 (Table 2). Open-ended questions were used and informants were encouraged to elaborate on their companys experience in China. Secondary data consulted included annual reports, company websites, other published information on the Chinese operations of the retailers, various research reports on the development of the retail and distribution industry in China, and Chinese government websites. Entering China When questioned about why China was selected for investment, the four European retailers, two of the three from Hong Kong, one of the three Japanese and the US retailer claimed they were attracted by the consumption potential of 1.2 billion people and the rapid economic development of China. While the attractions of the huge potential of the Chinese market were tempered by a realistic appreciation of the challenges, all respondents expressed a strong belief in China becoming one of the worlds most important retail markets. Three out of the eight retailers also acknowledged that sourcing was an important secondary reason for investing in China. A European retailer claimed that they sourced goods from China valued at 400 million per annum. A Japanese retailer also confirmed that China is a major supplier to their business in Japan. A Hong Kong retailer emphasised the potential value of their retail operation in China for improving the quality of sourcing for their Hong Kong stores though it was reported that some foreign-owned producers in China are resistant to supplying the premium market of Hong Kong. Clearly the possibility of improving control over sourcing, offsetting buying costs and, perhaps more importantly, the opportunity to use transfer pricing to secure cash flow from China are attractive hedging options. Sentimental attachment figured prominently in the motivation behind investments by three retailers in the sample. One of each was headquartered in Hong Kong, Japan and Taiwan. The company founders claimed they had always wanted to contribute to the modernisation of Chinas retail and distribution industry. These high-minded ideals were also combined with recognition of the saturation of domestic markets and the attractions of the new retailing frontier of mainland China. Internationalisation The twelve FMCG retailers were asked to explain why they set up operations outside their domestic market. In terms of more general motives for overseas expansion, four of the twelve FMCG retailers highlighted the importance of building up general buying power in order to drive down supplier margins, expand cash flow and avoid being ‘eaten up’ by competitors. One European retailer identified the accumulation of ‘know-how power’ (knowledge of different markets in the world) as another reason for expanding overseas. Another asserted that national boundaries are ignored in the endless search for opportunities to make money. While domestic market saturation encouraged retailers to look at overseas expansion it was never the prime motive. Enhanced buying power and the prospect of growing profitability were the key drivers. Three retailers also admitted to searching for an international image and a corporate goal of becoming a significant global FMCG retailer. The recent admission by Tesco, the United Kingdoms largest FMCG retailer that it has been looking for a suitable Chinese partner for more than two years is further confirmation of the attractions of the China retail market to aspirant global players (Child, 2002, 2). Retailing Space China has statistical retail potential in abundance. Geographical coverage of modern FMCG retail outlets is very limited. Table 3 compares the number of supermarkets and hypermarkets in a number of European countries with Shanghai, the most developed Chinese city. Only Hungary has a lower density of supermarkets and hypermarkets than Shanghai, the most prosperous urban centre in China. In practice, China has only a relatively small affluent population that has the financial means to afford sophisticated products and services. China offers room for retailers to experiment with retail formats, merchandising, assortments, etc. to build up customer awareness and loyalty. Western, Hong Kong and Japanese media penetration is still quite limited and in any case is subject to strict government controls. This means awareness of, and aspiration for, goods associated with a foreign life style is underdeveloped. However, the emerging dualism of urban China — a larger group of less well-off people living alongside a smaller group of wealthier people — generates opportunities for foreign retailers. While foreign retailers may dream of the full blossoming of the retail sector, today they are able to cover their costs by selling goods to the affluent segments of urban society (Nakata and Sivakumar, 1997, 462). Crucially, it enables them to accumulate knowledge of the China market and prepare for future expansion. In terms of supply chain management, there are a number of institutional and infrastructure constraints. In the past, foreign retailers were prevented from expanding freely across China because it was difficult to centralise buying activities across provinces due to regional protection. It is hard for a retailer to exert effective quality control over the existing multi-tiered supply chain. Many local producers need advice on how to respond to retailers requirements with respect to food preparation, packaging and delivery scheduling yet the complex, predominantly state-owned wholesaling system makes this very difficult to achieve. In addition, the penetration of information technology into supply chain management is limited to large, mostly international consumer goods manufacturers. Logistics remains one of the greatest challenges facing the development of a modern integrated distribution and retail sector in China. Another important constraint on the development of modern retailing is the shortage of experienced retail staff. First mover foreign retailers have had to invest heavily in training local staff at all levels and then face fierce competition from later entrants who seek to poach promising managerial talent, particularly in the cities of Beijing, Guangzhou, Shanghai and Shenzhen. The constraints on foreign penetration of the Chinese retail sector discussed above are a sample of the major ones. They are unlikely to disappear completely for some years although China is investing very heavily in its transport and communications infrastructure and is rapidly liberalising the logistics and wholesaling sectors. Remaining entry and operational barriers protect not only domestic retailers but also successfully established early movers. The real challenge for foreign retailers is to make appropriate adjustments to strategies and overcome existing constraints and to convert statistical potential into customers, cash flow and operating profits. Sourcing From China Sourcing is a critical activity in retailing because it determines gross margins and the range and reliability of the assortment of products offered to consumers. The retailing sector in many developed countries is experiencing intense competition and increasing concentration (Liu and McGoldrick, 1995, 13). As a result, retailers have to pursue alternative profit-enhancing strategies to raising prices. For example, in the UK, the major retailers are responding by seeking to leverage their brand names in non-food lines where margins are higher than in foods. Since China is emerging as the consumer goods export processing centre of the world, major retailers are increasingly likely to have a buying office in China already. In the 1950s, Drucker described similar beneficial effects of Sears, Roebucks activity in Mexico, identifying the stimulation of local producers to improve product quality as particularly important. Dawson (1993, press) claimed that this motive for internationalisation appeared to be less appropriate in the 1990s than in the 1950s because improvements in telecommunications meant that close contact with manufacturers was no longer necessary. While this may be true for more mature markets with well-developed logistics systems, our evidence suggests that with respect to China, the volume of business, both domestic and export-oriented, is an important driver behind retail investment. In China, where marketing channels are underdeveloped, there remains considerable scope for searching for reliable producers who can match the required quality standards. Time and effort are, nevertheless, still needed from foreign retailers to train local manufacturers to hit international standards. Long-Term Strategic Objective: Dominating the Supply Chain An alternative way of analysing international retail strategy is to focus on the appropriate ‘spatial strategy’ and the performance of the network of all retail outlets in the global chain. In growing a network the challenge is to develop a strategy that enables a retailer to cover sufficient territory to increase brand visibility with customers at the local store level and with suppliers at a global level. By creating an expanding and efficient network, a retailer can increase buying power and cash flow while improving margins. A number of studies have confirmed that a key retailing objective is to extract better terms from suppliers, and because negotiation over prices and conditions of supply with suppliers depends inter alia on purchasing volume and capacity, the pursuit of increased market share is an important strategic objective (Kacker, 1986, 12). Certainly, the Chief Operating Officer of Company F believed that multinational suppliers look at all overseas subsidiaries of a multinational retailer as more or less a unit. If a retailer is the biggest in terms of scale in each country where the multinational supplier is present, the retailer will have very strong bargaining power. Company F is ranked among the top three FMCG retail companies in the world in terms of global sales. Approximately one-third of turnover is generated from operations outside its home country and multinational FMCG manufacturers respond to its global scale by providing ‘key account’ privileges: supply priority and competitive prices. There is no doubt that pressure on prices and hence on costs is very strong (Pellegrini, 1994, 123). However, being able to secure supplier guarantees over product specifications and quality and over the reliability of delivery schedules is also of considerable importance, not least in an emerging market beset with logistics problems. Suppliers risk incurring monetary penalties if they violate these ‘guarantees’ (Keh and Park, 1998, 103). Chinas WTO Membership and Its Implications Since Chinas accession to the WTO in December 2001 and against a background of slowing world economic growth, exports have grown by 20%, to US$262 billion in the ten months to the end of October 2002, generating a trade surplus of US$24.7 billion; 52.8% of export trade was attributed to foreign invested enterprises. Real GDP growth was 7.3% in 2001 and the indications are that private consumption is continuing to grow. Retail sales grew by 8.4% year on year in the first quarter of 2002, slightly weaker than the 10.1% growth recorded in 2001 and the 9.7% rate achieved in 2000 (EIU, 2002). The Chinese government is determined to accelerate the process of transition to a modern market economy. This was reflected in the deliberations of the 16th National Party Congress held in November 2002. Jiang Zemin, the outgoing Party General Secretary, among other things chose to stress the Partys commitment to introducing better safeguards for private property. Members of the business elite were also elected for the first time to the Central Committee of the Communist Party. The Ministry of Foreign Trade and Economic Cooperation (MOFTEC) announced that it was introducing legislation to permit mergers and acquisitions of state-owned enterprises (SOEs) by foreign enterprises by early 2003. Despite the impressive public commitments of the political elite to the effect that government organisations will be continuously reformed and streamlined, it will take time for reforms to work their way through to all provinces and municipalities. No doubt already progressive local authorities will take full advantage of the new opportunities provided by the pro-market policies being introduced at the centre. Elsewhere, the general weakness of institutions, the poor performance of some SOEs and the high level of indebtedness of state banks will slow reform. Nevertheless, the transparent commitments of the central government to the WTO now provides a legitimate basis on which foreign investors can challenge any arbitrary interference by local officials. China made several specific concessions on its accession to the WTO that have a direct bearing on the wholesaling, retailing and logistics sectors. Foreign companies will be allowed to import and distribute most products by 2004. New regulations permitting foreign equity ownership up to 49% in the wholesaling and logistics sectors allow full ownership after three years. This means that international retailers, manufacturers and third-party service companies are being encouraged to invest in the full range of logistics services such as storage and warehousing, packaging, trucking, air courier services, freight forwarding, after-sales servicing and the provision of consumer credit. U.S. and EU officials are actively monitoring Chinas commitments to reform entered into as part of its WTO accession agreement with the US government and European Commission. As the modernisation of the Chinese economy progresses and the heavy investment in infrastructure continues, problems afflicting the retail sector that arise from under-developed transportation and telecommunication systems should fade away, as they have already done in several of the coastal provinces. Government investment in tertiary education and management development by foreign retailers has already greatly improved the supply of retailing expertise. The problems that stem from the reservation of wholesaling and distribution for SOEs and domestic private business and equity caps on foreign retailers will also gradually disappear. Will the china dream come true? China is a market many perceive as providing tremendous retailing space and opportunities for development of foreign FMCG retailers. The country is also an important strategic sourcing location for non-food consumer goods, which are playing an increasingly important role in the competition to maintain average retail margins at an international level. Nevertheless, China may not be a market as easily and readily conquerable as foreign FMCG retailers hope. First, despite the success of a number of foreign FMCG retailers, some retailers have already withdrawn their investment in China. For example, Royal Ahold, a leading retailer from Holland, aggressively entered China with a supermarket format in 1996. Within three years, it had developed 45 stores in prime locations in Shanghai. However, in December 1999, the company sold its stake in the stores to its local, joint-venture partner, Zhonghui. The reason for Royal Aholds departure from China was that the company could not foresee profitability in the country in the medium term (Horler, 2002). According to the Bangkok-based Chief Financial Officer of CRC Tops (a wholly-owned subsidiary of Ahold), the 45 stores in China only amounted to 1% of Shanghais supermarket business and it was estimated that it would take more than five years to reach break-even. The main board considered this to be too long (Fink, 2001). Prior to the entrance of Royal Ahold, local supermarkets in Shanghai were mostly poorly organised and managed. The majority of Chinese consumers preferred to do their food shopping in the daily wet market. Aholds stated aim on entering China was to revolutionise the offering of fresh food in a supermarket environment by simplifying the supply chain and by providing fresher produce in-store than available in wet markets. After about 18 months, Ahold had its systems working satisfactorily but what they had not anticipated was the capacity of local retailers to learn and improve following Aholds example. The two largest local supermarket groups, Lianhua and Hualian, very quickly achieved the same quality standard as Ahold for fresh food. Furthermore, with help from local government who freed up sites for expansion, both enterprises were soon operating around 300 outlets each in greater Shanghai. Although the present study has not researched the reasons for the exit of Ahold in depth, entering China with a supermarket format does not appear to be an appropriate strategy because, at least in Shanghai, there are already too many local supermarkets. For foreign retailers the hypermarket format seems to be more appealing and more difficult to copy. One plausible explanation is the take-off of the concept of one-stop shopping. By using a large supermarket or hypermarket format with food and non-food lines in a ratio of around one to three, retailers are able to offer a store setting with basic modern shop fittings but products sold at much lower prices. This combination of ambience and price seems to create the more casual shopping experience that many Chinese consumers want. Second, domestic retailers in China have the potential to develop into significant rivals to foreign retailers. Some people may argue that local retailers do not possess the management and marketing skills that are crucial for the success of a retail business. However, the examples of Lianhua and Hualian, with over 300 supermarket outlets each and sales turnover that ranks them among Chinas top domestic business groups, demonstrate that with entrepreneurial flair and judicious help from local government with the all-important site acquisition process, it is possible to successfully challenge foreign rivals. Lianhua and Hualian may be special cases for the time being but as the retail and distribution industry develops, local retailers will gradually catch up. With active support from municipal governments, more Chinese retailers will develop the capacity to become serious competitors for foreign retailers. The development of the retail and distribution industry in China as a whole has been remarkably rapid over the last ten years and the advance of Chinese retailers may also occur at an amazing pace. In one local Shanghai hypermarket visited during fieldwork, there were posters all around the store announcing ‘The Chinese Peoples Own Hypermarket’. The immediate success of foreign retailers in China may not imply that imported retail formats and formulas are suitable for China in the long run. Indeed, regional variations in consumer tastes are also enormous so that, at the very least, assortments have to be adjusted to reflect local preferences. Demographic factors and consumer behaviour, of course, differ from Western countries. For example, household living space in China is very limited and consumers have a strong preference for fresh food. Consumers shop more frequently and leave with a smaller basket value than Europeans or Americans on each shopping trip. Many customers of hypermarkets walk to the store. For example, some Carrefour hypermarkets in Beijing, Chengdu and Chongqing do not offer a parking area around the store but operate as city centre stores, unthinkable in Europe. These stores with sales area in excess of 6000 square metres are essentially serving the affluent urban population living in the new high rise apartment blocks that have sprung up in the central areas of all the major conurbations of China. There must be some doubt about the sustainability of all existing foreign retail formats in China. Domestic retailers will catch up with foreign retailers in terms of size, retail information technology and management skills. At the same time, the ‘uniqueness’ of consumer behaviour in China is still only partially reflected in currently available retail concepts. Therefore, taking a long-term perspective, the fundamental factor that will determine the future competitive landscape of retailing in China is not who possesses the latest retail technology and systems, but who possesses the most relevant retail know-how in the context of China. There is still plenty of ‘space’ for new entrants — foreign or domestic. Conclusion This paper seeks to demonstrate that international FMCG retailers are rather proactive in the search for overseas expansion opportunities because they are driven by the underlying long-term strategic objective of achieving greater market power over their suppliers and competitors. Only the acquisition of such power will secure their survival in the marketplace, especially when national borders present less and less of an obstacle to retail concentration on a global scale. China offers space and opportunities for foreign FMCG retailers to expand the scale of their operations. The lack of fierce competition for the time being means that foreign retailers have time to experiment with their formats, assortments and merchandising. It also means there is time to develop an appropriate supply chain management and logistics system robust enough to cope with the demands of a store network being rolled out in the very varied conditions of the different provinces and municipalities of China. However, as the examples of Lianhua and Hualian in Shanghai demonstrate, some local retailers are very adept at appropriating ideas and techniques from foreign retailers. When supported by the municipal authority and cheap credit available to SOEs, they are quite capable of competing successfully with foreign retailers. It is this pervasive inter-penetration of business relations with state interests that makes China a peculiarly challenging environment in which to operate, the more so where site selection is critical to the success of a store and where the real estate market is highly imperfect. It is going to be a long time before all retailers domestic- or foreign-owned — compete on a level playing field. Fortunately the provincial and municipal authorities are not monolithic. Some tilt the playing field towards domestic interests and others towards foreign investors. Once a site has been secured and the store opened, then a whole new array of administrative hurdles may appear. Hence the importance not only of establishing good guangxi via a powerful joint venture partner to secure and develop a site, but also of maintaining active local connections with the municipal administration once the store has become operational. A golden rule of operating successfully in China is never to underestimate the capacity of the bureaucracy to push up costs for foreign-invested enterprises. References Child PN (2002) Taking Tesco global. The Mackinsey Quarterly No. 3, p.2. Dawson J (1993) The internationalisation of retailing. In: Bromley RDF and Thomas CJ (eds), Retail Change: Contemporary Issues. London: UCL Press. Dawson J (2001) Strategy and Opportunism in European Retail Internationalisation. British Journal of Management 12: 253–66. Euromonitor (2000) Consumer China 2001. London: Euromonitor, p.5. Fink R (2001) Royal ambition (Online). Available from URL: http://www.cfo.com/printarticle/0, 5317, 2512 1A 00.html [Accessed 24 November 2002]. Horler A (2002) Going global in the Asia-Pacific Region — Is Asia an exception to the rule? (Online). Available from URL: http://www.kamcity.com/library/articles/asia.htm [Accessed 24 November 2002]. Kacker MP (1986) Coming to terms with global retailing. International Marketing Review 3(Spring): 7–20. Keh HT, Park SY (1998) An expanded perspective on power in distribution channels: strategies and implications. International Review of Retail, Distribution and Consumer Research 8(1): 101–15. Liu H, McGoldrick PJ (1995) International sourcing: patterns and trends. In: McGoldrick PJ and Davies G (eds), International Retailing: Trends and Strategies. London: Pitman Publishing, p13-15. Myers H (1996) The changing process of internationalisation in the European Union. In: Akehurst G and Alexander N (eds), The Internationalisation of Retailing. London: Frank Cass, p.25. Nakata C, Sivakumar K (1997) Emerging market conditions and their impact on first move advantages: an integrative review. International Marketing Review 14(6): 461–85. Pellegrini L (1994) Alternatives for growth and internationalisation in retailing. International Review of Retail, Distribution and Consumer Research 4(2): 121–48. Yip LSC (1995) The emergence of a retail market in China. In: Davis H (ed.), Business in China, pp. 251–67. London: Longman. Read More
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