Study on the Future

Opportunities and
Challenges of EU-China
Trade and Investment
Relations

Study 8:
Distribution/
Retail

Study Experts:

Stephen Michael
Alexander van
Kemenade
Casper Jacobsen

A project implemented by:

“This report was commissioned and financed by the

Commission of the European Communities. The views
expressed herein are those of the Consultant, and do
not represent any official view of the Commission.”

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 1

EXECUTIVE SUMMARY
China represents a great opportunity for
international retailers, and due to a relatively
liberal investment environment, offers a
greater potential than many other service
sectors. The dual attraction of a large and
fast-growing domestic market, together with
the extensive sourcing opportunities, makes
China an indispensable part of any
international retailer’s global strategy.
Competitive Strengths and Market
Opportunities
For European retailers, the future potential in
the Chinese market is positive. Chinese retail
and wholesale sales of consumer goods are
expected to reach more than EUR 618 billion 1
by the end of 2006. Of this figure,
approximately 4% of sales (EUR 24.7 billion)
are by foreign retailers. Assuming current
growth trends continue, the total value of sales
in the Chinese market could increase to around
EUR 916 billion by 2010. European retailers
should be able to capture a significant portion of
these sales. China’s comparative advantage lies
in leveraging its vast pool of surplus unskilled
labour through labour-intensive manufacturing.
Competitiveness in retail, however, is gained by
focusing on lean operations, supply chain
management, integrated procurement,
effective quality controls and management
flexibility as well as the ability to identify with
local consumer preferences. Due to the
weaknesses of Chinese competitors in these
areas, predictions based on current market
trends suggest that the foreign-owned market
share could double by 2010.
Recent surveys suggest that a new type of
consumer is emerging in China, one that does
not mind paying up to 20% more to ensure
product quality, particularly when it comes to
food safety. Foreign retailers are in a prime
position to take advantage of the increasing
disposable incomes of China’s inhabitants.
European companies have been among the
most pioneering in ensuring food safety,
helping to build consumer trust and boost the
competitiveness of food retailers as well as
increasing productivity for distributors.
Obstacles to Trade and Investment
While challenges to European and other
foreign retailers largely remain operational in
nature (e.g. recruitment and retention of
talented staff, streamlining fragmented and
old-fashioned distribution networks, etc.)
there still remains some regulatory challenges
which restrain foreign retail expansion. While
many of these elements are not strictly
speaking in conflict with China’s WTO
commitments, they are often not implemented
transparently and involving excessive red tape
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
for foreign retailers. These include limits on
total store outlets a foreign majority owned
company can open up, limits on store size, and
limits on the sale of certain products. Even
though local authorities can now authorise the
opening of new stores, some provisions
stipulate that central-level approval must still
be sought after certain thresholds have been
surpassed (e.g. number of stores in China). A
number of other non-regulatory obstacles also
exist, such as difficulties in obtaining land-use
rights, and a lack of transparency, particularly
in sub-sectors such as media. Counterfeiting is
also a problem, particularly for brand-reliant
products.
Policy Recommendations
1. Lobby the Chinese government for equal
regulatory treatment of foreign retailers
including:
a. Removing the conditions on foreign
majority ownership.
b. Removing the conditions for
central-level approval.
c. Removing the remaining product
restrictions
d. Clarifying or abolishing city planning
requirements.
2. Improve and enhance the use of
methodologies to assess impacts of
proposed EU anti-dumping measures,
which can often hurt European retailers
(and consumers) sourcing goods from
abroad. While there are currently
instruments in place such as the
Community Interest Test, there has been
some criticism of its effectiveness.
3. Support Chinese customs reform to ensure
uniform implementation of the WTO
Customs Valuation Agreement, and reduce
Customs formalities. This may be achieved
through the Trade Facilitation negotiations.
Some priority areas for the negotiations
include reduction of excessive
documentation requirements and greater
coordination among local customs
authorities to prevent inconsistencies in
valuation procedures. Onerous testing and
certification requirements (and in many
cases inconsistent application) also makes
the importation of goods a problem for
retailers operating in China.
4. Establish inquiry points for market entry,
which can be especially helpful for SMEs as
they navigate the complex administrative
infrastructure.
Recommendations for Competitiveness
Since European retailers already find
themselves in a competitive position vis-à-vis
2
domestic retailers, few radical changes in the
current direction of European retailers are
recommended. Nonetheless, a few important
key principles are emphasised.
1. Build scale. Currently, no single retailer in
China is large enough to leverage
cost-cutting logistics capabilities in
procurement, inventory management and
distribution.
2. Be involved in local/community policies.
For an industry where each new store
requires approval, good relations with
both the central and local government are
arguably the most important asset for
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
expansion in China.
3. Be flexible. China houses a kaleidoscope
of different consumer preferences and
regulatory environments.
4. Aggressively manage supply chains. As
retailers cut production costs by sourcing
from China, problems remain with rising
costs from supply chain impediments.
5. Be actively involved in the development of
trade policy in Europe and lobby on behalf
of consumers.
3
TABLE OF CONTENTS

Executive Summary ........................................................................................................................... 2

1. Introduction .................................................................................................................................. 7
2. Overall Sector ................................................................................................................................ 7
2.1 China in the global context................................................................................................7
2.2 Consumption Patterns .......................................................................................................8
2.3 Recent reforms ............................................................................................................... 10
3. Entry and Expansion of Foreign Retailers in China ............................................................ 12
3.1 Race for Market Share ..................................................................................................... 12
3.2 Forms of Foreign Investment: JV vs. WFOE ........................................................................ 14
3.3 Geographic Expansion ..................................................................................................... 14
4. Competitiveness Issues .................................................................................................... 17
4.1 Concentration................................................................................................................. 17
4.2 Expansion Strategies: M&A vs. Organic Growth .................................................................. 17
4.3 Productivity and Profitability............................................................................................. 17
4.4 Challenges and Opportunities ........................................................................................... 18
5. Remaining Market Access Obstacles ................................................................................. 21
5.1 Regulatory Restrictions .................................................................................................... 22
5.2 Transparency-Related Issues ............................................................................................ 24
6. Outlook and Scenarios ...................................................................................................... 25
6.1 Scenario 1 - Baseline....................................................................................................... 25
6.2 Scenario 2 - Optimistic scenario........................................................................................ 26
6.3 Economic Impact of Baseline vs. Optimistic Scenario ........................................................... 26
7. Recommendations............................................................................................................ 27
7.1 Policy Recommendations.................................................................................................. 27
7.2 Recommendations for Competitiveness.............................................................................. 28
Annex 1: Distribution/Retail Government Structure ........................................................................ 30
Annex 2: Table of Key Laws and Regulations Pertaining to the Retail Sector................................... 31
Annex 3: Factors Influencing Competitiveness in the Chinese Market ............................................. 32
Annex 4: Industry Survey Results ................................................................................................... 33

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 4

LIST OF FIGURES

Figure 1: China Retail & Wholesale Sales of Consumer Goods 1996-2010e....................................................8

Figure 2: Composition of Urban Household Expenditure 2005......................................................................9
Figure 3: Ownership Levels of Selected Household Goods ...........................................................................9
Figure 4: China’s Population Structure 2004..............................................................................................9
Figure 5: Sales by Store Format in 2004...................................................................................................9
Figure 6: Composition of Consumer Spending by Income Group ................................................................ 10
Figure 7: Composition of Retail Sales by Company of Origin in 2004 .......................................................... 12
Figure 8: Sales of Foreign Retailers by Store Format ................................................................................ 13
Figure 9: Number of Selected Foreign Retail Outlets in China by Region by Mid-2005 ................................... 14
Figure 10: Relationship between Provincial GDP per capita and Selected Retailers Hosted ............................. 15
Figure 11: Concentration Ration of Retail Industry in China....................................................................... 17
Figure 12: Main Advantages of European Companies in the China Market ................................................... 21
Figure 13: Strength of Chinese Competitors ............................................................................................ 21
Figure 14: Market Access Obstacles for European Companies .................................................................... 22

LIST OF TABLES

Table 1: Presence of Top 250 Global Retailers............................................................................................8

Table 2: Top 25 retailers in China 2005................................................................................................... 13
Table 3: Store numbers by region 2004 .................................................................................................. 15
Table 4: Key 2005 Provincial Indicators, ranked by GDP per capita............................................................. 16
Table 5: Performance Indicators by Company Origin in 2004* ................................................................... 18
Table 6: SWOT Analysis of European and Domestic Retailers ..................................................................... 20
Table 7: Economic Impact of Market Access Obstacles – Industry Survey Results......................................... 23

LIST OF BOXES

Box 1: Challenges for European companies to conduct business in the Chinese distribution sector - Voices from
industry.............................................................................................................................................. 23

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 5

ABBREVIATIONS

CCC China Compulsory Certification

CCFA China Chain store and Franchising Association
DIY Do It Yourself
DOFTEC Department of Foreign Trade and Economic Cooperation

EU European Union
EUCCC European Chamber of Commerce in China
FDI Foreign Direct Investment
FICE Foreign-invested Commercial Enterprise
FIE Foreign-invested Enterprise
FTL Foreign Trade Law
GATS General Agreement on Trade in Services
GDP Gross Domestic Product
GRDI Global Retail Development Index
HS Harmonized System
M&A Mergers and Acquisitions
MNC Multinational Corporation
MOFCOM Ministry of Commerce
RFID Radio Frequency Identification
SME Small and Medium-sized Enterprise
SWOT Strengths, Weaknesses, Opportunities, Threats
WFOE Wholly Foreign-Owned Enterprise
WTO World Trade Organization

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 6

1. INTRODUCTION delineated by retail format. Hence, unless
indicated otherwise, the retail sector will cover
the entire spectrum of products sold to
For the global retail industry, little question of a
end-users, with the exception of catering. Due
China ‘threat’, i.e. one that entails a flood of
to data compilation methodologies in China, it
low-price substitute goods from China,
will sometimes not be possible to separate
currently exists. Unlike in the manufacturing
catering from the rest, and to distinguish
sector, China still has little competitive
between wholesale and retail figures, though
advantage in the service industries and is
this shall be clearly indicated.
unlikely to develop such an advantage within
the 5-year period covered in this study. While
This definition, while broad, is a useful one for
Chinese retailers still largely dominate their
the purposes of this study, as the bulk of
home markets, there have been very few
European retail activities in China is done
successful attempts to break into overseas
through the hyper/supermarket format
markets.
(Chinese statistics do not distinguish between
hypermarkets and supermarkets). These carry
On the other hand, European retailers,
a highly diverse assortment of goods ranging
particularly the larger ones, have made
from food to household appliances and fashion.
successful inroads into the Chinese market.
Some focus will be given to the household
The Chinese distribution sector is often said to
appliances sector, however, this broad
be one of the most open to foreign investment,
definition will be adopted for the greater part
particularly after a series of reforms in 2005.
of the study.
In fact, European retailers sometimes
complain that it is not the Chinese competitors
or government which pose a risk to their 2. OVERALL SECTOR
business, but protectionist measures
stemming from home governments. This is 2.1 China in the global context
illustrated by the supply chain disruption
Despite falling from 4th to 5th place on the 2005
resulting from the 2005 textiles safeguards.
Global Retail Development Index 2 (GRDI),
China retains its position as one of the world’s
Nonetheless there remain some cross-sectoral
most attractive retail markets with a massive
challenges which stem from the complexities
consumer base, rising disposable incomes and
of doing business in China. Though some
a high rate of urbanisation. In 2005 retail
discriminatory and restrictive regulations still
sales 3 reached RMB 5659bn, making China the
exist, these are officially permitted under the
7th largest retail market 4 in the world and the
conditions of China’s WTO accession. There is
world’s largest emerging retail market.
plenty of red tape and a lack of transparency,
usually associated with some form of
Hence there has been no shortage of
corruption. Currently, few mechanisms in
international retailers entering the Chinese
international law exist to address such
market in recent years, particularly since the
obstacles; hence a positive approach that
2005 reforms, which in effect threw open the
seeks to highlight the benefits which European
doors of the domestic retail and distribution
investors can bring, rather than a “stick”
sector (see section 2.3 for details). This is seen
approach has been suggested by some of the
in the increase of foreign investment projects
companies interviewed for this study.
approved by the Ministry of Commerce
(MofCom). 1,027 foreign investment projects
This study will begin with an overview of
in retail and distribution have approved by the
China’s global role as both an investment
Ministry of Commerce since May 2005,
destination and a sourcing opportunity for
compared to only 314 approved for the 12
international retailers. It will then briefly touch
preceding years 5 .
upon consumption dynamics in China and the
development of the Chinese retail industry.
As a result, competition between international
Foreign investment in retail and European
retailers in China has intensified. This has
investment in particular, will then be examined
resulted in a drop in the nation’s ranking on the
in more detail. This will be followed by a
GRDI index, which includes market saturation
synopsis of regulatory developments and
as an important factor. By January 2006, 31 of
remaining obstacles.
the world’s top 250 retailers 6 had already
established operations in China, ranking it
A broad scope of retail sub-sectors shall be
11th (see Table 1) in terms of presence of
covered in this study. Due to the rise of
MNC retailers. By comparison India, Asia’s
large-scale retailing and the diversification of
second largest emerging market and No.1 on
inventories, product-delineated classification
the GRDI, hosts only 5 of the top 250 retailers
of retail sub-sectors makes little sense, and it
in the world.
is more appropriate to view the sector as

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 7

Table 1: Presence of Top 250 Global Retailers exports. This has led some commentators to
remark that if Wal-mart were a country, it
Rank Country No. would be China’s 7th largest export market,
ahead of Taiwan and Russia.
1 US 120
2 Japan 62 These observations point to the fact that for
3 UK 61 international retailers, China’s role as a
4 France 45 sourcing destination still takes prime
5 Canada 44 importance when compared with its role as a
market. Due to relatively late liberalisation of
6 Germany 43
the distribution sector, foreign investment has
7 Spain 41 been limited, and international retailers have
8 Italy 36 as of yet barely scratched the surface of this
9 Poland 32 vast market. This is due to change however, as
10 Netherlands 32 foreign retailers increase their presence in the
growing Chinese economy.
11 China 31
12 Belgium 30
2.2 Consumption Patterns
13 Portugal 29
Retail sales of consumer goods have been
14 Austria 26 following a path of steady growth for the last
15 Czech Rep. 24 10 years, averaging 10.1% growth a year,
16 Ireland 24 roughly in line with growth of per capita urban
17 Switzerland 23 disposable incomes, which have grown at an
average clip of 10.9% for the same period to
18 Taiwan 23
reach RMB 10,493 in 2005. A trend line
19 Denmark 22 forecast suggests that by 2010, retails sales
20 Puerto Rico 21 will reach RMB 9.2 trillion (Figure 1).
Source: Deloitte, Emerging Market Group 2006
In terms of the composition of consumption,
In addition to the domestic market, China food is by far the largest item of urban
provides a valuable opportunity to household expenditure in China, accounting
international retailers in the form of sourced for 36% (Figure 2). However, as incomes rise,
goods. While exhaustive data on sourcing by this figure has gradually declined while relative
retailers is not available, some indication of the spending on items such as transport and
scale can be given by looking at figures made communication has been on the rise. This is
available by individual retailers. Wal-mart, particularly noticeable for automobiles, mobile
Carrefour and Metro together exported USD phones and personal computers. Household
23.8 bn worth of goods from China in 2004, ownership levels of these products has
which exceeded total domestic retail sales of increased 6.8-, 7- and 4.3-fold respectively for
FIEs in China for that year. The largest the period 2000-2005. 7
exporter is Wal-mart with USD 18 bn worth of

China Retail & Wholesale Sales of Consumer Goods 1996 – 2010e

10 9.2
8.3
7.6
8 6.9
6.2
5.7
RMB trln

6 5
4.5
4.1
3.3 3.6
4 2.8 3
2.4 2.6
2

0
96

97

98

99

00

01

02

03

04

05

e
06

07

08

09

10
19

19

19

19

20

20

20

20

20

20

20

20

20

20

20

Source: China Statistical Yearbook 2006, Emerging Markets Group 2006

Figure 1: China Retail & Wholesale Sales of Consumer Goods 1996-2010e

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 8

 structures (though for very different reasons),
Composition of Urban Household with a constrictive pyramidal shape that peaks
Expenditure 2005 in the late 30s (Figure 4) 9 As a consequence,
retailers in China will have to adapt their
Food inventories and retail formats to match an
36% ageing population. The rapid rate of China’s
urbanisation will provide retailers with
higher-density clusters of customers in the
Clothing
Other
10% long-run. The proportion of China’s population
3%
residing in urban areas has risen from 29% in
Housing Household 1995 to 43% in 2005, and the government has
10% appliances and signalled its intention to continue encouraging
services 6% migration from the under-employed
Recreation,
Cultural and
countryside.
Education Health
14% 8% Transport &
Communication China's Population Structure 2004
13%

Source: China Statistical Year Book 2006

Figure 2: Composition of Urban Household 90 to 94 Male Female
Expenditure 2005
80 to 84
One can expect this trend to continue in the 70 to 74
long run as incomes continue to rise. As a
rough comparison, food spending accounted 60 to 64
for only 13% of household spending in the
50 to 54
Age
EU-25 in 2003. Urban ownership levels of
household goods in China, while having risen 40 to 44
considerably over the past 2 decades, are still
30 to 34
relatively low. Figure 3 outlines the growth of
ownership levels in selected household goods. 20 to 24
If the big ticket spending items in the 80s and
90s were refrigerators and washing machines, 10 to 14
then the current decade is marked by air 0 to 4
conditioners, computers and mobile phones.
Despite rapid growth, ownership levels still 0 20000 40000 60000 80000
remain relatively low and there remains Population
considerable room for growth (only 3.4% of
urban households own a car and 41.5% own Source: China Statistical Yearbook 2006
PCs compared to roughly 46% and 55% in the Figure 4: China’s Population Structure 2004
EU-25 8 ).
The most popular store formats continue to be
super/hypermarkets, specialty stores, and of
Ownership Levels of Selected Household Goods course (though these are not documented),
wet markets and neighbourhood grocers (see
Figure 5).
Units per 100 households

160
Mobile Phones
140
120 Sales by Store Format in 2004*
100
Air Conditioners Other
80
1%
60 DVD Players
Microwaves Convenience
40 PCs Stores
2% Department Stores
20 13%
0
2000 2001 2002 2003 2005 2006e Specialty Stores 40%
44%
Source: China Statistical Yearbook 2006 Hyper/
Supermarkets
Figure 3: Ownership Levels of Selected
Household Goods

Population dynamics can also be expected to *Data for firms with sales exceeding RMB 5 mn
have a significant impact on consumption Source: Statistical Yearbook of China
Retail Corporations 2005
patterns in China. Interestingly, China and
Europe share remarkably similar population Figure 5: Sales by Store Format in 2004

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 9

 Composition of Consumer Spending by Income Group
100%
80%
60%
40%
20%
0%
2000
Source: China Statistical Yearbook, Emerging Markets Group 2006
Figure 6: Composition of Consumer Spending by Income Group
However, recent surveys have shown Chinese
consumers to be moving away from traditional
to modern, large-scale formats for food safety
and convenience reasons. It is also interesting
to note at this point how store formats in China,
particularly hypermarkets, differ from their
European or American counterparts. This
requires a look at Chinese consumer
preferences. Compared to a Western consumer,
the typical Chinese hypermarket shopper
tends to spend less (between RMB 60-70) per
trip, prefers fresh produce and consequently
makes more frequent trips. They are also likely
to be overtly interested in hyeine and tend not
to won a car.
Hence a typical hypermarket in China will be
located in densely populated urban areas, with
several store levels (due to space constraints).
They will stock lots of fresh produce (rows of
live fish tanks, for instance), have smaller
pushcarts, a considerably higher number of
checkout lanes and no parking lots. Chinese
food products also tend to be packaged in
multiple layers of wrapping.
Another observable trend in consumer
spending stems from the growing disparities of
income distribution in China. While disposable
incomes of ‘high’ income groups have doubled
in the 2000-2005 period, those of ‘low’ income
groups have seen much slower growth –about
30%- over the same period (see Figure 6).
Hence, higher income groups are seeing a
surge in consumer spending, contributing to
an exploding market for big ticket items such
as cars and luxury goods.
Finally, the composition of GDP growth in
China is worth mentioning briefly in the
context of consumption patterns. Domestic
consumption for the last few years was at
around 40% of GDP growth, approximately 20
percentage points lower than the average
developed economy. Growth has mainly been
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
High
Mid-High
Mid
Mid-Low
Low
2005
driven thus far by investment and exports,
despite government efforts to drive down the
disproportionately high savings ratio by
suppressing deposit rates. The main reason
cited for this phenomenon is the inadequate
social safety net, which leads consumers to
save for a rainy day, as well as the
underdeveloped consumer credit market. As
China develops its consumer credit, pension
and insurance systems and other aspects of
social welfare, one can expect domestic
consumption to increase at a faster pace than
growth in population and disposable income.
2.3 Recent reforms
Prior to China's WTO accession, foreign
investment in the distribution sector was
heavily restricted. In accordance with China’s
services schedule and Article V paragraph 1 of
China’s accession protocol, a gradual approach
was taken to open the distribution sector and
now, four years after accession, China’s
distribution sector has been significantly
liberalised in terms of provision of services and
international trading rights. China’s GATS
commitments cover the following sub- sectors:
1. Commission Agency services consist of the
sales on a fee or contract basis by an agent,
broker or auctioneer or other wholesalers
of goods/merchandise and related
subordinated services.
2. Wholesale Trade services consist of the
sale of goods/merchandise to retailers to
industrial, commercial, institutional, or
other professional business users, or to
other wholesalers and related
subordinated services.
3. Retail services consist of the sale of
goods/merchandise for personal or
household consumption either from a fixed
location (e.g., store, kiosk, etc.) or away
from a fixed location and related
subordinated services.
10
4. Franchise services consist of the sale of the
use of a product, trade name or particular
business format system in exchange for
fees or royalties. Product and trade name
franchises involve the use of a trade name
in exchange for fees or royalties and may
include an obligation for exclusive sale of
trade name products. Business format
franchises involve the use of an entire
business concept in exchange for fees and
royalties, and may include the use of a
trade name, business plan, and training
materials and related subordinated
services.
The main focus of this report is on retailing
services. China’s service schedule prescribes
that three years after WTO accession, all
limitations on geographical location, number
of establishments, equity ratio and form of
establishment of foreign service suppliers as
specified shall be fully lifted, with a few
exceptions. The following sections highlight
the main legal reforms which were
implemented.
2.3.1. Foreign Trade Law Amendments
On 6 April 2004, amendments were made to
the Foreign Trade Law (1994) granting
international trading rights to Foreign Invested
Commercial Enterprises (FICE), a
newly-established type of legal entity. The
amendments allowed for free import and
export of goods and technologies and all
enterprises (including a FICE established
pursuant to the FICE Regulation) were granted
full trading rights under these amendments.
This provision, coupled with the subsequent
grant of distribution rights discussed below,
allowed foreign companies unprecedented
access to the Chinese market.
2.3.2. The FICE Regulation
Whereas the FTL amendments concern trading
rights, the Regulation on Management of
Foreign Investment in the Commercial Sector
(FICE Regulation) concerns the distribution
rights of FIEs. Distribution rights are
understood to include the right to engage in
the internal sale, offering for sale, purchase,
distribution or use of goods manufactured in or
imported into China. In accordance with WTO
commitments, all goods in respect of their
internal distribution are subject to national
treatment.
Prior to the passage of the FICE Regulation,
foreign companies were required to distribute
goods within China through JVs with a Chinese
partner. The FICE Regulation abolished this
requirement, and introduced a new type of
foreign-invested enterprise, the
Foreign-Invested Commercial Enterprise (FICE)
which is permitted to distribute products
within China. In the past, this type of change
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
has been implemented gradually by the
Chinese authorities, with new regulations
introduced on a trial basis only, or with
significant restrictions, such as high registered
capital requirements and strict qualification
requirements for investors. However, following
December 11, 2004 the FICE Regulation
introduced significant changes with relatively
few restrictions.
2.3.3. Ownership and Entry Thresholds
The FICE Regulation generally allows Wholly
Foreign-Owned Enterprises to distribute their
full portfolio of goods throughout China.
Certain quantitative entry barriers were also
reduced. Entry threshold in terms of registered
capital, average annual turnover and assets
for foreign entities were lowered substantially
for foreign invested enterprises. Effective from
11th December 2004, foreign retail enterprises
were required to have a minimum of RMB
300,000 registered capital, and Wholesale
enterprises were required to have a minimum
of RMB 500,000. This is a marked departure
from the previously prohibitive requirements.
Requirements were removed on average
annual sales and assets, 10 and geographical
restrictions on the opening of new stores were
abolished, effectively opening the national
market.
2.3.4. Application Process and Delegation of
Approval Authority
The application process for obtaining FICE
status involves two steps. The application
must first be submitted to the provincial-level
Department of Commerce and Foreign
Economic Cooperation (DOFTEC) approval
committee for preliminary review. Thereafter,
the application is submitted to the
central-level of MofCom for approval. The FICE
regulation stipulates that the entire approval
process should be completed within four
months. Guidelines issued by MofCom in
August 2005 helped clarify the procedure for
establishing a FICE and European enterprises
are now reporting that applications submitted
are being dealt with within this four month
period and have generally allowed for a
smoother application process.
As of March 2006, local DOFTECs are now in a
position to approve new FICE establishments
without central-level approval. This has been
welcomed by the foreign industry as a positive
step in the liberalisation of China’s distribution
and retail sector, however, at present there are
no experiences to verify the smooth operation
of the new responsibilities of the local DOFTEC.
In general, the application documents required
in order to obtain FICE status are identical to
the requirements for other foreign-invested
enterprises (FIEs). However, the FICE
11
regulation introduces one notable addition to
the requirements for retail FICE operations:
foreign companies must now obtain a letter of
approval from the local government(s) for the
location of new outlets, indicating that
proposed new retail stores should adequately
conform to the urban and commercial
development plans of the local government(s).
Foreign industry has raised concerns on this
issue, as it gives local officials excessive
discretionary power in examining and
approving applications for setting up new
stores. This requirement also implies that
urban commercial development differs on a
regional basis. The foreign industry has raised
concerns that this restriction is liable to
irregular implementation across the Chinese
provinces and that local officials could abuse
such discretionary power as a market entry
barrier to restrict the number of foreign
distributor/ retailers while favouring Chinese
competitors 11 . MOFCOM is currently amending
its central guidelines for conducting urban
commercial planning at the regional level,
however, these are yet to be finalised.
3. ENTRY AND EXPANSION OF FOREIGN
RETAILERS IN CHINA
3.1 Race for Market Share
Liberalisation of the retail sector came at a
relatively late stage in China’s reform process,
with comprehensive lifting of investment
restrictions on December 11, 2004 – at least in
theory. Effective liberalisation came later in
2005 with the promulgation of new regulations
in April and December. While most leading
retailers had already established a presence in
China prior to this period, the relatively late
reforms have resulted in a heated race to open
or acquire new stores. FDI in the wholesale
and retail sector 12 accounted for a mere 1.2%
of total FDI in China in 2004. Although data for
2005 is not yet available, in view of the surge
in approved foreign investment projects in the
retail sector after the reforms, one would
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
expect a dramatic increase in FDI.
At an initial glance, it seems that foreign
retailers have gained a solid foothold in the
China market, with non-Chinese firms holding
about 11% (see Figure 7) of total retail sales in
2004. However, bearing in mind that data
collected in China only accounts for companies
with sales in excess of RMB 5 million, it is clear
that if smaller retail outlets were taken into
account the overall retail sales figures would be
much higher. Estimates vary therefore on the
sales share of foreign retailers in China,
however, it is likely to be between 3-4%.
Composition of Retail Sales
by Company Origin in 2004
Foreign
HK, Macau & 11%
Taiwan 6%
83%
Domestic
Data for firms with sales exceeding RMB 5 mn
Source: Statistical Yearbook of China Retail
Corporations 2005
Figure 7: Composition of Retail Sales by
Company of Origin in 2004
However, considering that the retail sector
has only become de facto liberalised in 2005,
foreign retailers have already notched up
some initial successes and are still expanding
aggressively. Of the 100 leading retailers by
sales in China, 17 were foreign (excluding
catering), contributing 20.6% of sales of the
top 100 (see Table 2). Among these 17 were
6 Europe-based companies, whose combined
activity accounted for 32.8% of sales by
foreign retailers in the top 100, more than
any other single non-domestic group.
12
Table 2: Top 25 retailers in China 2005
Current 2004 Sales (RMB Outlets
Company Name
Ranking Ranking mn) (No.)
1 1 Shanghai Brilliance Group (Bailian) 72,074 6,345
2 2 Beijing Gome Electronic Appliances 49,840 426
3 4 Su Ning Electronic Appliances 39,718 363
4 15 CR Vanguard (Hua Run Wan Jia) 31,299 2,133
5 3 Dalian Dashang Group 30,117 130
6 6 Beijing Hualian 20,800 74
7 10 Wumart Group 19,072 659
8 9 Nonggongshang Supermarket Group 17,549 1,572
9 5 Carrefour 17,436 78
10 n/a Shanghai Da Run Fa 15,700** 60
11 7 Shanghai Yongle (China Paradise) 15,166 199
12 12 Chongqing General Trading Group 15,054 191
13 16 Jiangsu Five-star Electronic Appliances 14,612 193
14 11 Shangdong San Lian Group 13,201 274
15 13 Trust-Mart 13,200 96
16 17 A. Best 11,801 79
17 n/a Parkson Group 11,000** 36
18 22 Hefei Department Store 10,500 54
19 21 Lotus 10,060** 61
20 19 Jiangsu Wen Feng Great World 10,001 612
21 20 Wal-mart 9,934** 56
22 23 Home World 9,217 82
23 30 Li Qun Group 8,229 643
24 18 Wuhan Wu Shang Group 8,072 42
25 26 Wuhan Zhong Bai Group 7,994 385
Europe-based Retailers in top 100
27 n/a Hymall-Tesco 7,920 78
28 24 Metro 7,546 27
38 48 B&Q 5,160** 48
40 36 Auchan 5,000** 13
50 n/a Lufthansa Department Stores 3,559 8
*Data excludes catering
**Estimates
Source: China Chain Store & Franchising Association

This may not come as a surprise as retailers of 86% of sales of foreign retailers in 2004. Sales of
European origin typically tend to have a globally foreign-invested Hyper/Supermarkets accounted
more diverse source of sales. While Wal-mart is for 21.5% of sales of all Hyper/Supermarkets in
by far the world’s largest retailer, only 19% of its China for the same year.
sales came from non-US countries in 2002 13 .
Sears, Roebuck and Co. likewise made 90% of
Sales of Foreign Retailers by
its sales within the US. Carrefour and Royal
Store Format 2004*
Ahold on the other hand, saw 49% and 80% of
sales in none-home base countries
respectively. 14 5%
Hyper/
Hyper/
Supermarkets Specialty Stores
Supermarkets
More non-European foreign retailers, however, 86% 86%
Convenience
5% Convenience
Stores 1%
are entering the market. While the present Stores
7% Single1%
- Brand
position of Europe-based retailers remains Boutiques
dominant, it still constitutes a decline from the 1%
position held by Europe-based retailers in 2003, Department Stores
when they held over 50% of sales by foreign
retailers in China. As for store formats, the data Corporations 2005
in Figure 8 shows clearly that the
mn
*Data for companies with sales exceeding RMB 5
Hyper/Supermarket format is the preferred Source: Statistical Yearbook of China Retail
choice for foreign retailers in China, comprising Figure 8: Sales of Foreign Retailers by Store Format

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 13

3.2 Forms of Foreign Investment: JV vs.
WFOE
Due to regulatory restrictions, foreign
investment vehicles in the pre-2005 period
were mainly limited to Joint-Venture models.
Despite the pitfalls of teaming up with a local
counterpart, local knowledge has proved
exceptionally useful in retail due to the strong
regional nature of retail operations.
China is often described as a kaleidoscope of
diverse markets with each region protecting its
own industries, resulting in fragmentation of
supply chains. Each region moreover has its
own opaque set of tax and finance rules and
different requirements for approvals. Local
partners are often able to help in managing
these regional complexities through their local
networks, as well as in building indispensable
good relations with local governments. Hence,
there was no rush to buy out JV partners
following the 2005 reforms as one might expect.
This is in contrast with other sectors considering
the degree to which foreign companies have
been complaining about their partners in
industries such as ICT and automotive. Foreign
retailers have adopted a flexible attitude,
buying out the more burdensome partners
while keeping the useful ones.
In addition, since localisation is encouraged by
the Chinese government, keeping domestic
partners contributes to the projection of a
strong local image, which has helped many
retailers minimise red tape and curry favour
with local governments. Some retailers even
consider this an essential strategy, considering
the plethora of approvals required to open new
stores and restrictions placed on 100%
foreign-owned companies. Nonetheless,
WFOE’s are the preferred type of investment
for most foreign retailers entering China
post-2004. According to the Ministry of
Commerce, roughly 61% of applications for
market entry by foreign retailers in 2005 were
under the WFOE format.
3.3 Geographic Expansion
In terms of geographic expansion, foreign
retailers have already established a solid
presence in first-tier cities and have already
began to move into second- and third-tier cities,
the populations of which having soared due to
urbanisation. Figure 9 shows, based on a
selection of global retailers, the geographical
distribution of foreign retailers in China. The
wealthier coastal regions, with cities such as
Shanghai, Beijing and Shenzhen, are not
surprisingly host to the highest density of stores.
We can also see that international retailers have
entered most of China’s provinces, with Tibet,
Ningxia, Hainan among the exceptions. Apart
from the coastal provinces, Sichuan province
with the mega-city Chongqing in central China
is also heavily targeted.
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
No. of Selected* Foreign Retail Outlets in China
by Region by Mid-2005
None
1-5 stores
6-10 stores
11-20 stores
More than 20 stores
*Walmart, Carrefour, Metro, Auchan, B & Q, IKEA, Lotus, Ito
Yokado, Tesco, Parkson, Leroy Merlin
Source: Ministry of Commerce 2005, Emerging Markets Group 2006
Figure 9: Number of Selected Foreign Retail
Outlets in China by Region by Mid-2005
Shanghai, Beijing and Shenzhen are the
wealthiest cities in China and consequently
boast a modern retail sector. These are the
first targets of foreign retail expansion in China.
They are already home to a large number of
supermarkets and hypermarkets, owing to
high population densities and a boom in car
ownership. While the hypermarket segments
tend to be dominated by foreign retailers,
domestic companies hold most of the market
in the supermarket segment, with SOE giants
like Lianhua and Hualian (Bailian Group) and
Nonggongshang in the lead.
Some cities, notably Shanghai are beginning
to see a convenience store boom, filled by the
rapidly-expanding number of suburban
residential compounds. Usually ranging from
300-1000 square metres in size, these stores
have filled a gap in the markets for formats
which are larger and cleaner than the
traditional Xiaomaibus 15 but more
conveniently located than larger 2000-3000
square meter supermarkets. Convenience
stores initially followed a 7-11 model
possessing in-house processing functions such
as the ability to serve warm, cooked foods, but
this model has seen limited returns on the
much higher investment required outside of
the major metropolises.
Many of the convenience stores chains such as
Quik, Kedi and Alldays, are owned by the SOE
giants like Bailian and Nonggongshang,
though Japan’s Lawsons and Family Mart, as
well as Taiwan’s C-Stores have already
established in Shanghai. 7-11, having gained a
foothold in southern China, is taking its first
steps in Beijing. While European retailers have
only made limited inroads, the convenient
14
retail format promises to become a stronger
feature of the retail landscape in China, with
store densities in cities such as Shanghai
already reaching European levels. Despite
some efforts from municipal governments to
curb the expansion of convenience stores due
to a desire to preserve the Xiaomaibus, retail
sales by convenience stores in China increased
by 65.5% to RMB 13.8 billion in 2004.
3.3.2 Increasing focus on 2nd and 3rd tier cities
Following entry into first-tier cities, international
retailers focused on the surrounding urban
agglomerations, particularly the Pearl River delta
(Guangzhou, Shenzhen), the Yangtze River delta
(Shanghai, Hangzhou, Nanjing) and the Bohai
rim (Beijing, Tianjin, Dalian, Shenyang), as
indicated by the 3 darkest areas in Figure 9.
Due to the lack of scale, nationwide distribution
networks are not yet feasible; however, these
three areas will form the basis for regional
distribution networks, which will to some degree
benefit from economies of scale. As foreign
retailers build their national presence and reach
a critical mass in the geographical distribution of
stores, they will be able to take advantage of
nationwide logistics platforms. Wal-mart
executives, for instance, have already pointed
out that China will be the only other country in
the world where the retailing giant will be able to
replicate its super-efficient logistics capabilities.
With coastal markets approaching saturation,
attention is shifting towards the inland. In 2004,
inland regions saw the highest growth in new
store openings; with the number of stores in
western China growing over twice as fast as in
the central or eastern regions. Moreover,
growth in store numbers in 2nd tier cities
(32.6%) outpaced those in 1st tier cities
(15.7%). The move inland is being driven
mainly by smaller specialty and convenience
stores which have less space requirements and
Relationship between Provincial GDP per capita and
Selected Retailers Hosted
60
50
40
No. of stores
30
20
10
0
0 5 10 15
GDP per capita (RMB '000)
Source: PRC Ministry of Commerce, Emerging Markets Group 2006
Figure 10: Relationship between Provincial GDP per capita and Selected Retailers Hosted
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
hence are able to be more flexible in choosing
location, typically around newly-built residential
communities. Since inland regions are usually
poorer, there is lower car ownership, and
therefore consumers tend to do their shopping
at a local, neighbourhood level, thus rendering
large-scale formats, which tend to be fewer in
number and require more travel to reach, less
attractive. This is reflected in Table 3. As one
moves west in China, the proportion of stores in
a large retail format diminishes.
Table 3: Store numbers by region 2004
Proportion
Overall
Change
of large
YoY
stores **
East 38170 14.2% 34.4%
Central 6696 15.1% 32.0%
Western 10025 37.7% 14.3%
*Data for stores with annual sales exceeding RMB 5 mn
**Large format covers Department stores, Hypermarkets
and Supermarkets
Source: Statistical Yearbook of China Retail Corporations 2005
GDP per capita has been identified through
correlation analysis as the most important
factor in drawing foreign investment in retail,
as suggested by the strong positive correlation
in Figure 10. Other important factors include
population and infrastructure development (as
measured by road density), as well as the
degree of urbanisation. Current household
wealth however, has not been the sole
consideration for international retailers.
Despite the emphasis on coastal regions,
investment has reached more remote and
impoverished provinces such as Qinghai,
Gansu and Xinjiang, with Carrefour already
running two stores in Urumqi (which do not sell
pork, owing to the large Muslim population in
Xinjiang).
20 25 30 35 40 45 50 55
15
The two Xinjiang Carrefours illustrate
Carrefour’s expansion strategy in China, which
so far has worked well and made the
France-based firm the leading foreign retailer
in China in terms of sales. Xinjiang is one of
China’s most impoverished regions, making it
an unattractive destination for most
international retailers. Only Carrefour and
Malaysia-based Parkson have so far ventured
into the western province. Short-term gains
seem to be less of a concern in the case of the
French chain. Securing prime locations in
major cities nationwide is of much more
priority, as shown by Carrefours’ expansion in
2000-2001, where it had ignored central-level
approval and dealt directly with local
governments in opening new stores. The
central government reacted by freezing
Carrefour’s expansion for over a year, but by
then the stores had already been opened and
the best locations were secured.
Carrefour has been commended for
demonstrating the flexibility required to do
business in China, while its competitors, such
as Wal-mart, have been criticised for getting
bogged down in negotiations at the expense of
valuable expansion time. Table 4 provides an
overview of Chinese provincial indicators
ranked by GDP per capita.

Table 4: Key 2005 Provincial Indicators, ranked by GDP per capita

GDP per % of
GDP per
Province / capita Total Retail Sales Population population
Rank capita 2005
Municipality CAGR (RMB bn) (mn) living in
(RMB)
2001-2005 urban areas

1 Shanghai 51486 10.3% 245 17.8 89.1%

2 Beijing 44774 11.6% 219 15.4 83.6%
3 Tianjin 35452 14.6% 105 10.4 75.1%
4 Zhejiang 27435 14.3% 365 49.0 56.0%
5 Jiangsu 24489 15.3% 416 74.8 50.1%
6 Guangdong 24327 9.9% 637 91.9 60.7%
7 Shandong 20023 16.3% 448 92.5 45.0%
8 Liaoning 18974 10.1% 264 42.2 58.7%
9 Fujian 18583 9.9% 200 35.4 47.3%
10 Inner Mongolia 16327 20.4% 89 23.9 47.2%
11 Hebei 14737 13.5% 252 68.5 37.7%
12 Heilongjiang 14428 10.8% 156 38.2 53.1%
13 Jilin 13329 12.0% 125 27.2 52.5%
14 Xinjiang 12956 10.9% 48 20.1 37.2%
15 Shanxi 12458 16.9% 88 33.6 42.1%
16 Hubei 11419 13.0% 267 57.1 43.2%
17 Henan 11287 16.0% 281 93.8 30.7%
18 Chongqing 10974 15.6% 96 28.0 45.2%
19 Hainan 10804 9.4% 22 8.3 45.2%
20 Hunan 10293 13.3% 207 63.3 0.0%
21 Ningxia 10169 12.0% 14 6.0 42.3%
22 Qinghai 10006 12.8% 12 5.4 39.3%
23 Shaanxi 9881 13.7% 97 37.2 37.2%
24 Jiangxi 9410 13.9% 106 43.1 37.0%
25 Tibet 9069 11.0% 6 2.8 26.7%
26 Sichuan 8993 13.9% 238 82.1 33.0%
27 Anhui 8783 12.3% 150 61.2 35.5%
28 Guangxi 8746 14.3% 97 46.6 33.6%
29 Yunnan 7804 9.8% 88 44.5 29.5%
30 Gansu 7456 12.2% 54 25.9 30.0%
31 Guizhou 5306 13.4% 58 37.3 26.9%
Source: China Statistical Yearbook 2006, Emerging Markets Group 2006

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 16

4. COMPETITIVENESS ISSUES compiled in China for retailers with sales in
excess of RMB 5 million, thus excluding the
omnipresent Xiaomaibu - small-scale,
4.1 Concentration family-run convenience stores. 17
The retail industry can generally be
characterised as a highly competitive industry 4.2 Expansion Strategies: M&A vs.
with low levels of concentration, low-entry Organic Growth
barriers and high-entry and exit rates. There Due to increasing levels of market saturation
are typically a large number of relatively small and fragmentation of the industry, expansion
companies competing with naturally through mergers and acquisitions (M&A) has
highly-differentiated products and with been an attractive option for retailers – both
location being an important competitive factor foreign and domestic - in China. Most retailers
(a convenience store located in a residential are choosing M&A as a fast-track growth
area has obvious advantages over one in an option - Tesco became a player overnight by
industrial complex). choosing to enter China through the
acquisition of a 50% stake in Taiwan-based
The exception is food retail, where, particularly Ting Hsin Group’s Hymall.
in developed countries, concentration levels
have seen notable increases in the recent M&A also represents a way to eliminate
decade, with the emergence of international competition. B&Q’s 2005 acquisition of 13
retailing conglomerates such as Wal-mart, stores from Tengelmann’s OBI effectively left it
Carrefour and Metro. In the EU, for instance, with one real competitor – home improvement
the top 20 food retailers accounted for 40% of market leader Orient Home. It also helped
sales. 16 B&Q jump 10 places up the Top 100 list to 38th
place, boosting its sales an estimated 156%
over 2004.
Concentration Ratio of Retail Industry
in China Most importantly, however, has been the push
to build scale, which allows retailers to drive
down purchasing costs and create value
Top 100 firms Top 10 firms
12% through high-volume, low mark-up
10% transactions. At the time of writing, the media
Market Share

8% has been reporting a silent bidding war

6% currently underway between giants Carrefour,
Wal-mart, Tesco and Lianhua for Taiwan-based
4%
Trust-Mart (15th place). Such a deal,
2%
regardless of which party wins, would be the
0% most significant act of consolidation for China’s
retail industry since the creation of Bailian (see
4

5
9

0
9

next section), as offers from all 4 bidders are

19

20

20

20

20

20

20

Source: China Chain Store & Franchise Association
Figure 11: Concentration Ration of Retail
Industry in China
China’s retail industry however, is highly
fragmented, with the top 100 retailers
accounting for 10.5% of total retail sales in
2005 (see Figure 11). While a wave of
government-backed industry consolidation is
taking place, competition remains fierce.
Some retailers have pointed out that the
distribution of profit margins across the supply
chain are inverted: Where in Europe
manufacturers see the lowest margins,
followed by distributors, and retailers seeing
the highest, in China it appears to be the other
way around. While it will still take some time
before concentration levels reach the same
level as Europe, one can expect these levels to
increase in coming years.
The current degree of industry fragmentation
makes comprehensive data very difficult to
obtain. To simplify matters, statistics are only
reported to have been in excess of USD 1 bn. 18
Domestic companies are participating in
government-backed efforts to build scale,
none more so than state-owned mammoth
Shanghai Brilliance (Bailian), which has been
designated a ‘flagship enterprise’ in line with
the 11th 5-year programme.
Bailian was created in 2003 as the result of a
merger between then market leader Lianhua,
Shanghai Yi Bai, Hualian and Haomeijia. In
2005, Bailian took a 45% stake in Dalian
Dashang (no.5), another SOE, forming part of
a government-orchestrated effort not only to
resist the emergence of foreign retailers, but
also to create a national champion that will be
able to expand into overseas markets.
4.3 Productivity and Profitability
Foreign companies, with relatively advanced
business models, operational processes and
management, have on the whole achieved
greater profitability and productivity.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 17

Table 5: Performance Indicators by Company Origin in 2004*
Sales/ Sales/ m² of
Return on Return on
Store Format Company Origin Employee floor space
Sales Assets
(RMB '000) (RMB)
Domestic 1.46% 4.55% 520 15346
Overall HK, Macau & Taiwan 0.06% 0.18% 529 13984
Foreign 1.74% 5.33% 610 23965
Domestic 0.81% 2.58% 426 13400
Hyper/
HK, Macau & Taiwan 0.23% 0.64% 579 14000
Supermarkets
Foreign 1.22% 4.64% 643 27500
Domestic 2.09% 7.06% 698 18800
Specialty
Stores HK, Macau & Taiwan 0.92% 1.33% 270 30200
Foreign 2.43% 3.16% 722 9500
*Data for companies with sales exceeding RMB 5 mn
Source: Statistical Yearbook for China Retail Corporations 2005, Emerging Markets Group 2005

Margins, returns on assets, sales per employee, hyper/supermarket segment. As we saw in the
and even sales per unit of floor space are all previous section, hyper/supermarkets are the
significantly higher for foreign companies than most important segment for foreign retailers in
for domestic competitors, as shown in Table China, accounting for 84% of all sales by
5. foreign retailers with sales exceeding RMB 5
million in 2004.
Due to cutthroat competition, margins 19 are
razor-thin. The national average, comprising The source of revenues for many retailers is
foreign and domestic firms across all retail also worthy of mention. Because of the market
formats, is 1.41%, compared to 5.7% for power exercised by many of the larger retailers
non-food and 10.5% for food retail in the EU. they are able to negotiate extremely
While foreign retailers have the highest favourable conditions with suppliers. In many
margins in China, the gap in profitability cases, suppliers must pay a fee to retailers for
between foreign retailers and domestic ones, stocking their products. Large retailers are
particularly SOEs, is not as high as in other also often able to shift a significant proportion
sectors. A simple explanation for this fact is of market risk onto the suppliers by
that many SOEs enjoy monopoly status in their negotiating free return of unsold products.
sub-sectors due to restrictions on sales of
certain products, for instance in tobacco. 4.4 Challenges and Opportunities
Furthermore, SOEs receive the best store As is generally the case with foreign companies
locations from local authorities. in China, the competitive edge of foreign
retailers is maintained through their innovative
Another explanation for the low margins may product formats and streamlined management.
lie in the fact that the attention of foreign For instance, the now popular hypermarket
retailers’ management has been largely format was introduced by foreign retailers.
focused on expansion. Foreign retailers have Foreign retailers will no doubt continue to play
been expanding their number of stores at a key role in bringing innovative technologies,
around 20% a year. With so much of the such as RFID, to China in the future.
management’s attention on opening or
acquiring new stores, less focus is given to 4.4.1. Fostering and keeping talent
streamlining operations or on improving sales
Qualified supply chain managers are in great
of existing stores. The productivity gap
shortage in China. The China Chain store and
between foreign and domestic retailers is more
Franchising Association (CCFA) forecasts that
significant. This is not surprising considering
nationwide demand for personnel with
that state-owned retailers are obliged to retain
university-level logistics training will reach
staff in order to keep unemployment down. A
300,000, while there are only 5,000 logistics
visit to most state-owned department stores in
graduates annually. Considering that each new
China, with droves of idle blue-shirted
hypermarket requires around 400 new staff,
employees sipping tea and chatting away
including around 50 managerial staff,
behind the sales counters, will confirm this,
recruiting strategies take a high priority for
though this is starting to change in recent
retail executives in China.
years.
Competition among retailers is intense and
Looking more closely at different store formats,
salary levels for middle management are
one sees that the advantage of foreign
among the highest in the country. Foreign
companies is strongest in the

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 18

retailers are generally able to offer competitive
packages to most managers, and have been
the most pioneering in training staff. Most of
China’s qualified logistics professionals
received their training while working for
foreign companies. Carrefour and Wal-mart all
have training centres in China, and use strong
incentive schemes to retain their staff. Other
retailers have tried selective hiring practices,
such as targeting older workers, since workers
younger than 30 tend to move on quickly.
4.4.2. Managing supply chains
Foreign retailers have yet to leverage one of
the most crucial competitive instruments in
retail – lean logistics and efficient supply
chains. Foreign retailers currently have little
choice but to rely on local distributors as they
lack the type of scale required to be effectively
served by a nationwide distribution platform.
A survey of over 100 fast-moving consumer
goods retailers commissioned by the CCFA
revealed that overall satisfaction levels with
suppliers was only at 51% in 2005.
China’s local distribution networks are, as
mentioned earlier in this study, highly
fragmented and have very low levels of
technological sophistication. Shipments pass
through three, sometimes four distributors
before reaching the client. An industry
observer once remarked that a typical Chinese
distribution company consists of a driver and a
truck. In some provinces, trucks may even
come as a luxury and the more common
Sanlunche, tricycles outfitted to carry goods,
are sometimes relied upon.
This results in lost revenues and increased
costs for retailers. Another CCFA survey of 13
fast-moving consumer goods including various
toiletries and beverages placed the likelihood
of a customer in any given hyper/supermarket
finding at least one of the items to be
out-of-stock at 9.9%.
The situation however, is improving. The entry
of foreign 3rd Party Logistics providers has
heightened competition among distributors,
and the growing scale of retailers has put
pressure on distributors to consolidate in an
effort to counteract growing buyer power.
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
4.4.3. Differentiating Products
The early phase of China’s retail modernisation
was marked by intensive price competition in
an effort to win over notoriously
price-conscious Chinese consumers. A factor
which made it easier for foreign players to be
price-competitive in retail (a phenomenon
almost unheard of in other sectors) stems from
their ability to leverage global sales networks
to purchase in bulk from China. This however,
only works to a certain extent since many
goods sold on the Chinese market have small
differences between those sold on overseas
markets. (For instance, Chinese mobile phones
typically have small holes on the side so that
the user can tie a string to it and hang it
around his/her neck, or hang a keychain on it.)
Price wars, however, eat into margins and
retailers are exploring ways of differentiating
their product. Focus fell on store environments
and service, and some retailers began to
radically experiment with different ideas.
Recent surveys suggest that a new type of
consumer is emerging in China, one that does
not mind paying up to 20% more to be assured
of product quality, particularly when it comes
to food. A recent CCFA survey raised various
problems associated with the distribution of
food products including the use of unsafe
storage materials, the absence of
comprehensive cold chains, and generally the
lack of compliance with hygiene standards
during transport. The International Quality and
Productivity Centre estimates that around
25-30% of fresh vegetables and fruit is lost
during shipment.
Retailers operating in other segments have
differentiated themselves by offering
after-sales services. For instance, B&Q have
moved away from the DIY concept to home
improvements by offering comprehensive
interior design and installation services. This
has been particularly effective in China due to
increasing levels of home ownership in recent
years, and the lack of Chinese enthusiasm for
doing ‘it’ oneself.
SWOT Analysis
Table 6 summarises the Strength,
Weaknesses, Opportunities, and Threats
(SWOT) of European and Chinese retailers
discussed in this section.
19
Table 6: SWOT Analysis of European and Domestic Retailers
Europe
Strength
- Superior management, business models,
operational processes, after-sales service and
capital
- Ability to leverage global networks
- Innovative product formats
China
Strength
- Established local brands, suppliers, trading
networks, clients and partners, government
relationships
- SOEs have government backing (financial
support, ability to obtain good store locations
etc.)
- Rapidly modernizing, able to adopt
international best practices through JV
partners

Weakness Weakness
- Less familiarity with local business - No global networks
environment, consumer preferences - Less advanced operational processes/
business models
- SOEs driven by non-commercial goals i.e.
employment
- Poor understanding of foreign consumer
preferences

Opportunity
- Sourcing of made-in-China goods for global
markets
- Sourcing of foreign-made goods for Chinese
market e.g. wine
- Large and growing Chinese consumer market
Opportunity
- Large consumer base from which to base
overseas expansion
- Proximity with and good knowledge of local
manufacturers/suppliers from which to base
overseas expansion
- JV partners good source of management
expertise

Threats
- Government support for competitors
- Poor supplier efficiency
- Political backlash against foreign investment
- Economic nationalism, negative publicity
Threats
- Foreign retailers winning market share
- Gradual abolition of government support
- Foreign protectionism (for those Chinese firms
expanding overseas)

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 20

According to the industry survey conducted by strengths (20%) identified include familiarity
the consortium implementing this study, and knowledge of local market conditions and
European companies believe that product the ability to fully concentrate on their home
innovation constitutes the main advantage market without the need to consider global
European companies have over Chinese operations as MNCs do.
companies (23.3% of times mentioned,
Figure 12). Here, it is noted that products
produced by European companies are Strength of Chinese Competitors
generally more geared towards consumer
needs then those made by their Chinese
counterparts. Strong human resources of Upgrading of
experienced and well-trained staff are also Capabilities of 33.3%
Local Companies
highlighted as being an important asset in
maintaining a competitive advantage in the
Chinese marketplace (20% of times Government
26.7%
mentioned). International brand name Support &
Intervention
recognition, and the quality and service
provision of European retailers is also
highlighted by survey respondents as a Lower Cost 20.0%
strength (both received 16.7% times Base
mentioned) Research and technological
development accounted for a further 13.3% of
response while 10% indicated ‘other’ 20 Other 20.0%
reasons.

Times Mentioned
Main Advantages of European
Source: Emerging Markets Group;
Companies DEVELOPMENT Solutions (2006)
Figure 13: Strength of Chinese Competitors

Innovative 23.3%
Products 5. REMAINING MARKET ACCESS
OBSTACLES 21
Human
Resources 20.0%
Section Topic
5.1 Regulatory Restrictions
Marketing & 5.1.1 Conditions on Majority Ownership
Branding 16.7%
5.1.2 Special Approvals
5.1.3 Rules Pertaining to Existing Manufacturing
Quality & Foreign Invested Enterprises
Service 16.7%
5.2 Transparency Related Issues
5.2.1 Customs Problems
R&D and
Tech. Dev. 13.3% 5.2.2 Media Distribution
5.2.3 Real Estate Prices

Other 10.0%
Times Mentioned
Source: Emerging Markets Groups.
DEVELOPMENT Solutions (2006)
Figure 12: Main Advantages of European
Companies in the China Market
Despite these strengths, surveyed companies
expect the strength of Chinese competition to
steadily increase over the next five years. The
capabilities of Chinese companies such as
quality, design, technology and foreign
know-how are improving, and thus present an
increasing threat to European companies
(33.3% of times mentioned, Figure 13).
Government support and intervention (26.7%)
in the industry is expected to further Chinese
companies’ growth in the sector and with their
lower cost base (20%), Chinese companies will
become increasingly more competitive. Other
Despite the 2005 reforms, some restrictions
still remain, such as the limit on the total
number of outlets a foreign majority owned
company can open up, limits on store size, and
limits on the sale of certain products. Even
though local authorities can now authorise the
opening of new stores, some provisions
stipulate that central-level approval must still
be sought after certain thresholds have been
surpassed (e.g. number of stores in China).
This suggests that the government is keeping
a wary eye on foreign retailers becoming too
dominant. A number of other non-regulatory
obstacles also exist, such as difficulties in
obtaining land-use rights, and a lack of
transparency, particularly in sub-sectors such
as media. Counterfeiting is also a problem,
particularly for brand-reliant products such as
fashion.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 21

Although the Chinese distribution sector is
positively regarded as offering significant
opportunities for European retailers over the
next 5 years, representatives from the
European distribution industry have identified
the following market access obstacles, (see
Figure 14) which continue to inhibit growth
and competitiveness.
Market Access Obstacles for
European Companies
Lack of
Transparency in
Operating Practices
Complex
Bureaucracy and
Government
Intervention
Lack of Legal
Framework
Limited Supply
10.7%
Channels
IPR
Infringements 7.1%
Other 21.4%
Times Mentioned
Source: Emerging Markets Groups;
DEVELOPMENT Solutions (2006)
Figure 14: Market Access Obstacles for
European Companies
Chinese operating practices such as a lack of
transparency in operating practices (25%) was
considered by surveyed companies to be
significant obstacle to expansion in China.
Complex bureaucracy and government
intervention, especially at the provincial level
also create barriers for European companies
operating in the Chinese market (17.9%). In
this regard, registration requirements for
foreign invested companies are noted to be
more stringent than for local competitors.
The lack of an adequate legal framework and
constantly changing product standards also
hinders European companies (17.9%). Limited
supply channels prevent European companies’
further access to the Chinese market (10.7%).
Furthermore, the participating foreign
representatives mentioned IPR infringements
(7.1%), and other obstacles (21.4%) to
expansion including lack of financial resources
and the language barrier. Box 1 provides
selected quotes from industry representatives
in relation to challenges to be met in the
Chinese distribution sector. Annex 3 provides
a visual summary of both market driven
competitive forces as well as those derived
from NTBs.
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
The market access obstacles in China can have
economic impacts on European companies
operating in China. The respondents reported
that as a foreign company they operate at a
higher cost than Chinese companies due to the
above mentioned barriers. One respondent
estimated that operation costs are
approximately 10-15% higher than those of
local companies. Obstacles such as import tax,
for which Chinese companies receive tax
breaks, results in of revenue constraints of
4-5%. Overhead costs are estimated to be as
high as 90%. See Table 7 on the following
page for selected comment from the industry
25.0%
survey regarding the economic impact of
market access obstacles.
17.9%
5.1 Regulatory Restrictions
5.1.1 Conditions on Majority Ownership
17.9%
The FICE regulation outlined in previous
sections still poses some obstacles and is
discriminatory in nature, imposing restrictions
on foreign ownership, store size, number of
stores, and merchandise sold. For instance,
foreign ownership is limited to 49% ownership
ceiling if the retailer should meet all of the
following conditions:
1) The retailer has over 30 shops in China
2) The retailer sells any product listed as
restricted 22
3) The retailer sells products with multiple
brands from multiple suppliers
The first condition is straightforward.
Authorities are keeping a close eye on any
retailer becoming too large and eventually
taking significant chunks of the domestic
market from domestic companies. Carrefour,
Wal-Mart, Metro and B&Q have already
exceeded this threshold.
The second condition is also fairly
straightforward. The restricted products (see
footnote 22) form part of China’s WTO
accession protocol, which is the list of products
subject to state trading. Powerful vested
interests in China’s SOEs are naturally keen on
seeing competition kept to a minimum in their
respective sectors, and none more so than
tobacco, regulated by the aptly-named China
Tobacco Monopoly Administration. An
unconditional ban exists for selling tobacco
products, and foreign investment in the sector
is close to non-existent. Liberalisation for some
of these products, namely, automobiles and
chemical fertilizers, is expected to come by the
end of 2006, in line with WTO commitments.
The third condition is perhaps the most
obscure as to its purpose. Selling products
from multiple suppliers is usually a practice
which encourages competition; it is usually the
practice of selling products from a single
22
Table 7: Economic Impact of Market Access Obstacles – Industry Survey Results
Where respondent made estimates
Comment Sub-sector
HP SM DP SS B CS O

“20% of turnover”- Wholesale to project developers and to

●
retailers
“4-5% à When we import fixed equipment we need to pay an
import tax but if we were a local invested company we would get ●
a tax-break.” – Business to Business
“Our estimated operating costs are approx 10-15% higher than
● ●
those for local businesses”
“We got only 1% sales turnover and market share in this
market, as compared with our globally turnover.” – Oil, ●
petrochemical, and power.
“In my business the current market situation results in an extra
overhead cost of about 90% that has to be recuperated from our ● ● ● ● ● ●
customers in comparison to other markets.”
Where respondents found it difficult to quantify market access obstacles:
Comment Sub-sector
HP SM DP SS B CS O

“This will be hard to predict since it involve not only current ●

market but also potential new market.”
HP: Hypermarket
SM: Supermarket
DP: Department Store
SS: Superstore
B: Boutique store
CS: Convenience stores
O: Other

product which falls under the scrutiny of
antitrust regulators, as this may be an
indication that the retailer is engaging in
exclusionary practices in order to share
monopoly profits with the supplier. Therefore,
it would seem strange that a practice which
promotes competition would be scrutinised. A
possible reason for this condition could stem
from the impact of retailers on their suppliers.
Dominant retailers are typically in possession
of enough buying power to negotiate
favourable conditions with their suppliers,
thereby forcing them to innovate and increase
their competitiveness, or risk going out of
business. It is likely that the suppliers of
influential SOEs, who would rather keep their
cosy relationships with the SOE retailers, are
reluctant to allow retailers to gain such a
position.

Box 1: Challenges for European companies to conduct business in the Chinese distribution sector -
Voices from industry
The following are a selection of quotations from interviewees and the returned questionnaires:

Q: What are the problems in doing business in China?

“After application procedure and requirements have been clarified our company has applied for a distribution
license, however, the application has been ongoing now for nearly a year and bureaucratic hurdles keep
delaying the process.”

“It is clear from the regulations that the central government does not want big retailers to expand too fast.
There are a number of extra approval requirements for larger chains, and restrictions on foreign ownership.”

“Our domestic rivals get big discounts on land and utilities and they get better store locations from the local
governments.”

“We’re losing at least 20% of turnover on counterfeits.”

“When entering new local markets in China we find that local authorities will have preferences for using locally
produced products.”

“The land auction system should prevent corruption but really favors only real estate giants and slows down
the process of getting a plot.”

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 23

5.1.2 Special Approvals
While, in principle, approval for new stores has
been devolved to local-level authorities, there
still remain a number of criteria and thresholds,
which, when passed, impose the obligation to
obtain central-level approval. If ANY of the
following conditions are met, there is an
obligation to obtain central-level approval:
1. The retailer engages in direct selling i.e.
engages in sales over TV, telephone, mail
order, internet or vending machines;
2. The retailer deals in restricted products
(covered in the previous section);
3. In the case of proposed new stores over
3,000 square meters, the foreign retailer
already has over 3 stores in that size
category in the province OR the foreign
retailer already has over 30 stores in that
size category in China;
4. In the case of proposed new stores over
300 square meters, the foreign retailer
already has over 30 stores in that size
category in the province OR the foreign
retailer already has over 300 stores in that
size category in China.
Direct selling was banned in China as a result
of the proliferation of pyramid schemes in the
90s. Currently, it remains somewhat of a
regulatory grey area; there has only been 1
licence awarded to a direct seller in China,
though in theory the practice is permitted. The
second, third and fourth conditions exist for
similar reasons covered in the previous
section.
5.1.3. Rules Pertaining to Existing Foreign
Invested Manufacturing Enterprises
The FICE regulation allows non FICE FIEs,
including those in manufacturing, to engage in
wholesaling, agency commissioning, retailing
and/or franchising provided they comply with
the FICE regulation and amend the scope of
their business accordingly.
Hence, apart from establishing new
Commercial Enterprises to engage in
distribution, foreign investors and
multinationals with existing FIEs in China are
allowed to apply to expand their business
scopes to include these additional activities.
Before the issuing of the abovementioned
guidelines by MOFCOM, local DOFTECs would
not accept any applications for the expansion
of business scope by existing FIEs, this issue
now seems resolved one year behind China’s
WTO schedule.
The delay was not necessarily because of the
desire to protect domestic companies, as has
sometimes been the case with delays in WTO
implementation in other sectors. Rather, it
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
appears to have resulted from the need for
MOFCOM to coordinate with other ministries
and departments, such as the General
Administration of Customs and the State
Administration of Taxation, to resolve various
technical issues. For example, the distribution
rights applications of bonded-zone companies
were left in limbo in part because MOFCOM and
Customs were still in the process of reaching
an agreement on whether to treat goods that
enter China from the bonded zones as imports
or as domestically distributed products. New
rules issued are basically in line with the
principles of WTO Valuation Agreement.
Manufacturing companies in China are eligible
for distribution rights under the condition that
revenues from distribution are kept below 30
percent of total revenue in order to continue to
enjoy current preferential tax policies for
manufacturing FIEs. Although uncertainties
still exist with regard to how authorities will
enforce this requirement.
5.2 Transparency-Related Issues
Despite positive developments in the
regulatory framework covering the distribution
sector, foreign companies still face a number of
non-tariff barriers related to transparency and
uniformity of implementation.
Transparency-related issues are very much part
of the daily business environment in China,
and all the more so for the retail sector, where
much of the business requires the involvement
by local authorities. In wealthier provinces,
local governments are perceived as being on
par with the central government in terms of
transparency, however in poorer provinces,
issues ranging from incompetence to
corruption constitute a obstacle for foreign
companies.
Typical transparency-related problems include
vague regulations which leave a wide scope for
administrative discretion, local protectionism,
protracted approval procedures, government
collusion with local businesses, administrative
‘power grabs’ (attempts to extract revenues or
gain business secrets and technologies
through new ‘regulations’), graft and bribery.
The biggest victims of such problems are
usually foreign SMEs. MNC investments are
usually high-profile, dealt with by senior
officials and welcomed because of the
state-of-the-art technologies and prestige
they bring to a province. Furthermore, MNCs
usually have dedicated government relations
personnel to handle administrative frictions.
Retailers who stock imported products also
typically face more problems than those who
sell locally-produced products. This may not
have so much to do with local protectionism as
it has to do with getting the goods into the
24
country’s borders. There is a number of
inconsistencies between central Customs
policy and local practice at the different ports
of entry.
5.2.1. Customs Problems
The European Chamber of Commerce in China
(EUCCC) has reported a number of cases
23
where official guidelines to companies on
import clearance procedures have not been
followed in practice. Import classification rules
are not interpreted at each port in a consistent
manner according to the Harmonised System
(HS), and in some cases, decisions are
influenced by the duty rates. Steps are being
taken by the General Administration of
Customs (GAC) to establish an internal
national tariff classification ruling database but
it remains to be seen whether this will resolve
issues of consistency in customs ruling.
Valuation problems also persist, as post-WTO
rules stipulate that the transaction value shall
serve as the primary basis for determining the
dutiable value of imported goods. However,
European companies are reporting cases
where Chinese customs officers continue to
use minimum or reference price lists or in
some cases even another company’s import
values to challenge the import transaction
values of imported goods. Customs officers are
required to provide written explanations when
they challenge the transaction value of
imported goods. However, European
companies have reported various cases where
the Chinese customs are reluctant to provide
such written explanations and if provided,
written justifications lack detailed
explanations or objective analysis and
reasoning.
5.2.3 Real Estate Prices
One of the major complaints of nearly all the
retailers interviewed for this study concerned
artificially high real estate prices. As
competition intensified over prime commercial
real estate, so have prices, which soared to an
extent where one interviewee’s price was as
high as Western European levels. In addition,
foreign retailers are reporting a 4.
non-transparent allocation system for land. A
land auction system put in place to combat
corruption has little effect, and large developers
are still being favoured in awarding plots.
6. OUTLOOK AND SCENARIOS
Based on current trends the following
outcomes are identifiable and could result in
the following types of scenarios by 2010.
6.1 Scenario 1 - Baseline
Scenario 1 constitutes the baseline scenario
and assumes that the current trends of
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
European retailers’ expansion in China
continue, although not quite at the pace that
has previously been the case. China’s economy
continues to see strong GDP growth, while
government policies toward retail and
domestic consumption in general are not
expected to change. No major changes to
China’s current exchange rate policies are
assumed and there are no major events which
would alter the Chinese consumer’s perception
or valuation of foreign goods.
Assumptions:
ƒ GDP continues to grow at a similar rate
experienced over the last five years.
ƒ No dramatic revaluation of the Yuan, the
government relies on foreign demand to
sustain economic growth through exports.
ƒ The government remains nominally
supportive of foreign investment in the
retail sector. However, conditions on
majority ownership will constrain growth
somewhat because thresholds limiting
ownership to 49% are increasingly met. In
addition, as attractive retail location sites
become scarcer it becomes relatively more
difficult for foreign retailers to obtain
regulatory approval for building on certain
cites (see Section 5 for further details).
Outcomes:
1. Total retail sales grow at an average rate of
10.1% until 2010, driven by strong growth
in disposable incomes, urbanisation and
population growth.
2. The market share of foreign retailers
doubles to 8%. The industry structure
supports a large number of less efficient
smaller retailers, in second and third tier
cities while larger national and foreign
retailers continue to consolidate the
concentrated and higher value markets in
urban areas located mainly along the
coast.
3. A low-value Yuan keeps exports and
sourcing volumes high, while keeping
Chinese consumer demand for imports
low.
Domestic retailers, due to their relatively
small-scale and a relatively weak Yuan are
not able to substantially expand their
presence abroad.
5. The overall share of European retailers in
the Chinese market will increase. However
their prominence among foreign retailers
will somewhat diminish (from 32.8%
today to around 27.5% in 2010).
Under this scenario, total sales in the Chinese
retail sector would reach RMB 9.22 trillion by
2010. With a market share of 8%, foreign
retailers would be responsible for around RMB
25
738 billion of these sales. For European
retailers, the market potential (at a 27.5%
market share among foreign retailers) could
reach up to RMB 203 billion by 2010.
6.2 Scenario 2 - Optimistic scenario
Under this optimistic scenario a high economic
growth rate is supported by a set of measures,
in particular the continuation and
strengthening of recent reforms, taken by the
Chinese government to boost domestic
consumption.
Assumptions:
ƒ GDP growth is assumed to be the same as
in the baseline scenario.
ƒ The government will promote higher
domestic consumption in order to
counterbalance potential risks that might
arise from an over-reliance on export
driven growth and foreign demand.
Measures could include making consumer
credit more widely available, a gradual
appreciation of the Yuan and visible
improvements in China’s social security
system.
ƒ The role of foreign retailers supporting
increased, more sophisticated, domestic
consumption by offering innovative
products and services not currently
available in the Chinese market is
recognised by the government. The
government remains supportive of foreign
investment in retail and allows industry
consolidation trends to continue.
Outcomes:
1. Measures to increase consumption pay off
with total retail sales growing at an
average rate of 12% per annum until
2010.
2. Domestic investment as well as FDI in the
retail sector accelerates to capture a share
of the growing market. Recent examples of
acquisition and expansion by foreign
retailers into the Chinese market 24 , as well
as consolidation among domestic players
will intensify 25 .
3. A slow, but continuous, upward trend of
the Yuan, combined with the increased
attention paid by foreign retailers to the
Chinese market, means that local sales
begin to overtake sourcing volumes for
overseas markets. An increased number of
retailers will have to offer better quality
products at competitive prices, while at
the same time, the increased purchasing
power of Chinese consumers (as a result of
a combination of continued economic
growth and a more valuable Yuan) means
there are new opportunities for foreign
retailers to offer their globally sourced
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
products to the Chinese consumer.
4. Foreign retailers expand their operations,
with some acquiring smaller and weaker
players, although most expansion occurs
by opening up new retail outlets 26 . The
need for organic expansion would be
particularly true in offering imported or
higher value goods and services to a new
urban middle class with increased
purchasing power. 27 The market share of
foreign retailers could triple to 12%.
Importantly, this increase in market share
would not be at the expense of domestic
retailers and would be the result of an
increase in supply of new products and
services appearing in the Chinese market.
5. Leading domestic retailers are able to
expand abroad with greater ease due to
international best practices adopted from
cooperation with international retailers
and a higher valued Yuan. Expansion will
begin to South East Asian markets. In
order to be able to expand abroad
adequate economies of scale will be
needed, creating further incentives for
industry consolidation while at the same
time further opportunities for cooperation
(e.g. sourcing/ distribution agreement;
legal partnerships, etc) between Chinese
and foreign retailers will arise.
Under this scenario, total sales in the Chinese
retail sector would reach over RMB 10 trillion
by 2010. By offering new products and
services valued by consumers, foreign
retailers could account for 12% of the market
(i.e. RMB 1.2 trillion of sales). For European
retailers taken alone, an estimate of market
potential may be made by assuming European
retailers are able to sustain their current
market share of 32.8% of foreign retail sales in
China. This would result in EU retail sales
totalling RMB 395 billion by 2010.
6.3 Economic Impact of Baseline vs.
Optimistic Scenario
Under the baseline scenario, the size of the
Chinese retail market is expected to grow to
RMB 9.22 trillion by 2010 where a slowdown in
reforms are expected and consumer spending
remains subdued. European companies are
expected to capture a 2.2% overall market
share valued at RMB 203 billion in sales.
In the optimistic scenario, where China is able
to make the radical transition from export- to
consumer-led growth, European companies
are expected to be able to gain a 3.9% market
share of a larger RMB 10 trillion market
(mainly due to an outward shift in the supply
curve). European companies would see a sales
value of RMB 395 billion by 2010.
26
If the Chinese government could therefore,
implement further radicals reforms, European
retailers would not only make RMB 192 billion
more in sales, but arguably the overall welfare
benefits (as measured by increased
consumption) for Chinese consumers under
such a policy could amount to up to RMB 780
billion 28 .
7. RECOMMENDATIONS
7.1 Policy Recommendations
Thus far, EU-China trade and investment in
retail has been largely beneficial for
European-based retailers. Foreign investment
in China’s retail sector is still encouraged by
the Chinese government, and Europe-based
retailers have done well in entering the
Chinese market at a relatively early stage and
building market share. Current obstacles
mainly relate to “soft barriers” such as red
tape which are largely manageable for large
retailers but much more burdensome for SMEs.
However, it remains to be seen how attitudes
and policies will shift as foreign retailers build
bigger market shares.
Before considering possible actions on the
policy level, it is important to note a distinction
on the one hand between those issues that
arise out of structural problems (i.e. those
which may be resolved only through long-term
growth and gradual improvement in the
quality of political, judicial and economic
institutions) and on the other hand those
issues which can be solved relatively easier.
Current regulatory barriers arguably fall
mostly in the latter category as these are
easier to target and to resolve. The restrictions
on foreign majority ownership and
requirements for central-level approval are an
obvious example of this and could be neatly
removed. Problems such as those relating to
transparency are much more difficult to deal
with, and require the long-term building up of
strong institutions such as an independent
judiciary and rule of law. Moreover, the central
government has limited power over the
practices of local officials and excessive foreign
pressure in this area is sometimes
counterproductive.
Hence, it is recommended that the European
Commission focuses its attention on
regulatory obstacles. Structural difficulties are
acknowledged by the Commission and
approached positively, highlighting the
benefits that European operators can bring to
China, particularly in accessing foreign
markets. Such an approach would address the
concerns of a large number of European
retailers that certain trade defence
instruments, including anti-dumping and other
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
safeguards, can result in difficulties for
European retailers sourcing from overseas.
Hence recommendations are also made to
mitigate such impacts.
Recommendations:
1. Lobby the Chinese government for equal
regulatory treatment of foreign retailers
including:
a. Removing the conditions on foreign
majority ownership;
b. Removing the conditions for
central-level approval;
c. Removing the remaining product
restrictions;
d. Further clarification or abolition of the
city planning requirement.
Most of these constraints on foreign
investment are not necessarily in conflict with
China’s WTO commitments and foreign
retailers have so far not reported any serious
obstacles emanating from these rules.
However, in the longer term, these issues lend
themselves to administrative abuse and some,
particularly the city planning requirement, are
implemented with no transparency. City
planning requirements, for example, are best
dealt with by independent rules and
regulations pertaining to the retail sector.
These regulatory constraints may be raised
bilaterally or as a part of further dialogues
under the WTO framework. It is also
recommended that technical assistance is
provided to MOFCOM and other government
institutions responsible for city planning with
the aim of finding better solutions to China’s
urban development challenges.
2. Improve and enhance the use of
methodologies currently used to assess
the impacts of proposed EU anti-dumping
measures, which can often hurt European
retailers (and consumers) sourcing goods
from abroad.
While there are currently instruments in
place such as the Community Interest Test,
there has also been some criticism of its
effectiveness 29 . Several measures can be
taken to improve the test:
a. Conduct ‘active’ rather than ‘passive’
investigations. While current
Commission practice provides
interested groups with the opportunity
to communicate their concerns, it does
not proactively seek out and identify
affected groups. While the interests of
manufacturers are commonly
represented in a concentrated form e.g.
through associations, consumer
27
 interests are more diffuse and may be
more difficult to consider. It is therefore
advisable that Community Interest
assessments include quantitative
analysis through the use of economic
models.
b. Studies have found that community
industry size does not form a part of the
community interest analysis. The scale
of community industry should be
incorporated into the assessment.
Certain industries in the EU are
relatively small and the costs associated
with the imposition of measures are
disproportionate incurring negative
impact. For example, job-losses are
often factored in as absolute are only
short-term and in declining industries.
c. The theoretical basis of many
anti-dumping actions is based on
unrealistic assumptions regarding
competition, i.e. that firms in exporting
countries are cooperating to lower
prices, thereby putting community
industry out of business so as to raise
prices later, and that competition from
third countries is non-existent.
Consideration should be given to
whether or not collusion among
exporters really exists and the extent to
which third country competition is a
contributing factor.
3. Support Chinese Customs reform to
ensure uniform implementation of the
WTO Customs Valuation Agreement, and
reduce Customs formalities. This may be
achieved through the Trade Facilitation
negotiations. Priority areas for the
negotiations including the reduction of
excessive documentation requirements
and greater coordination among local
customs authorities to prevent
inconsistencies in valuation procedures.
Onerous testing and certification
requirements and in many cases their
inconsistent application also makes the
importation of goods a problem for
retailers operating in China.
4. Establish inquiry points for market entry,
which can be especially helpful for SMEs as
they navigate the complex administrative
infrastructure. Areas where inquiry points
could be of assistance include advice on
regulatory issues and approval procedures,
liaison with administration officials,
information on customs procedures,
reliable local suppliers and distributors,
and general advice on business conditions
in China.
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
7.2 Recommendations for
Competitiveness
Since European retailers already find
themselves in a competitive position with
respect to domestic retailers, few changes in
the current direction are recommended.
Nonetheless, a few important key principles
are emphasised.
Recommendations:
1. Build scale. Currently, no single retailer in
China is large enough to leverage
cost-cutting logistics capabilities in
procurement, inventory management and
distribution. Retailers should focus on
opening new shops and acquiring existing
retailers. Current fragmentation of the
industry provides for many potential
targets, and at a good price.
2. Be involved in local/community policies.
For an industry where each new store
requires approval, good relations with
both the central and local government are
arguably the most important asset for
expansion in China. Retailers should focus
on leveraging their abilities to deliver
economic benefits to China’s regions
through e.g. employment.
3. Be flexible. China is a kaleidoscope of
different consumer preferences and
regulatory environments. What works in
one region will not necessarily work in the
other. JV partners can be useful in this
regard.
4. Aggressively manage supply chains. As
retailers cut production costs by sourcing
from China, the problem lies with costs
arising from supply chain impediments.
Distribution networks are highly
fragmented and one should expect poor
service from local distributors. Challenges
may include counterfeiting, lack of
tracking systems and poor levels of
automation, lack of customer credit etc.,
all of which contribute to the remarkably
high stockout rate of Chinese retailers.
5. Be involved in trade policy at home and
speak out for the consumer. While
manufacturers’ interest groups are
extremely active in defending their
interests, European governments need to
hear more from consumer groups and
retailers on trade issues. It is up to retailer
and consumer associations to ensure that
both positive and negative impacts are
fairly represented to policymakers.
28
REFERENCES
Buyer power and its impact on competition in the food retail distribution sector of the European Union,
Dobson Consulting, Office for Official Publications of European Communities, Luxembourg 1999

China Chain Store Almanac, China Chain Store & Franchise Association, 2005

China Statistical Abstract, China Statistics Press,2006

China Statistical Yearbook, China Statistics Press, 2005

Distribution and retail in the PRC, Freshfields Bruckhaus Deringer 2005

Distribution services: Note by the UNCTAD Secretariat, United Nations Conference on Trade and
Development 2005

Europe in figures - Eurostat Yearbook 2005, Eurostat 2006

European Business in China: Annual Position Paper 2006/2007, European Chamber of Commerce in
China, 2006

Global Retail Development Index 2005, A.T. Kearney 2006

Global Powers in Retailing 2006, Deloitte 2006

Moving Forward on Distribution, US-China Business Council, 2005

Regulatory Reform in Retail Distribution, OECD Economic Studies No. 32, 2001

Retail: Food Sector, All China Retail Annual Report 2006, GAIN Report, USDA Foreign Agriculture
Service, 2006

Statistical Yearbook of China Retail Corporations in Chain, China Statistics Press, 2005

UNCTAD World Investment Report 2004, United Nations Conference on Trade and Development, 2005

White Paper 2006, American Chamber of Commerce in China 2006

Websites:

China Chain Store and Franchise Association

www.ccfa.org.cn

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 29

ANNEX 1: DISTRIBUTION/RETAIL GOVERNMENT STRUCTURE

State Council

Organisation Composing Ministries Directly Affiliated Organs Working Offices

Layer

Key National Ministry of Commerce State Administration of General Administration Legislative

regulatory Development & (MOFCOM) Industry and Commerce of Quality Supervision, Affairs Office
bodies Reform Commission (SAIC) Inspection and
(NDRC) Quarantine
(AQSIQ)
Department of
Industry,
Communications
and Commerce
• Domestic market • Establishing an open, • Approving, organizing • Quality control at
Relevance
analysis competitive and regulated and supervising macro-level
• Participating in
• Drawing up market mechanism retailers and their • Formulating and
making relative
modern logistic • Monitoring and regulating activities Implementing quality
laws and
development market operation • Commodity quality control standards
regulations
strategy control in circulation

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 30

ANNEX 2: TABLE OF KEY LAWS AND REGULATIONS PERTAINING TO THE RETAIL SECTOR

Key Laws and Regulations

Catalogue of Industries for Guiding Foreign Investment （Revised 2004）;

Measures for the Administration on Foreign Investment in Commercial Fields promulgated on April
16, 2004.

According to these two regulations, the commitments have been implemented.

New relevant regulations include but not limited to:

Law on Import and Export Commodity Inspection amended on 28 Apr 2002

Regulations for Compulsory Product Certification entry into effect

Measures on the Administration of Wholesale, Retail and Lease of Audio and Video Products
2002-3-28;

Decision of the Ministry of Culture on Revising the “Provisions of the Ministry of Culture on the
Administration of Foreign-related Culture and Art Performances and Shows”, and Other
Regulations 2004-7-1.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 31

ANNEX 3: FACTORS INFLUENCING COMPETITIVENESS IN THE CHINESE MARKET

In addition to the genuine market driven
competitive threats posed by Chinese
operators in this sector, European companies
also face competitive forces as a result of
non-tariff or ‘behind the border’ barriers.
Those NTBs which are deemed to result from
strong Chinese government intervention are
plotted on the right of the horizontal access
while those derived from genuine competition
are plotted to the left. The author has indicated
the relative importance of these competitive
forces in terms of their position on the vertical
axis with those nearer the top deemed as the
most significant. The graph is designed as a
guide only to give some perspective to the
descriptions of competitive forces in this
sector.

Factors Influencing Competitiveness of European Distribution

Companies Engaged in China-Related Business

MARKET DRIVEN Nature of Competitiveness MARKET DISTORTING

HIGHER

Upgrading of Capabilities
Chinese Competitors

Chinese Operating Practices (1)

Lower Cost Base
Chinese Competitors
Ownership Restrictions (2)

Knowledge of Local Market Complex Bureaucracy

Chinese Competitors
Lack of Legal Framework
Customs Procedures

Unequal Access to Supply Channels

Special Approvals (3)

IPR Infringement

Language Barrier
Financing (Discriminatory Access)

LOWER
Impact on Competition

Notes: (1) Chinese operating practices here refer to a lack of transparency, corrupt practices and other forms of
graft. (2) See Section 5.1.1 for further details. (3) See Section 5.1.2 for further details.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 32

ANNEX 4: INDUSTRY SURVEY RESULTS

Distribution

SECTION 1: SECTOR OVERVIEW

1.1 Sample group profile

Table 1 – Sample Group Profile

MNC SME
WFOE 6 WFOE 1
JV 1 JV
Both 1
Total 8 Total
% Sample 89% % Sample 11%

1.2 For how many years has your company been engaged in China-related business?

Chart 1 – Length of Engagement in China-related Business Activities

< 5 years, 22%

>10 years, 56%

5 to 10 years,
22%

Generally speaking the companies surveyed have substantial experience of operating in the
Chinese market. All of the foreign companies participating in the survey have conducted business
in the Chinese market for more than five years. 56% of the companies surveyed have at least 10
years of experience. 22% of the companies have 5 to 10 years of experience in China. 22% of
those surveyed have had established offices in China for at least 5 years.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 33

1.3 Which market segments does your China business operate in?

Table 2 – Market Segment Operating In

Market Sector No. of Responses %

Hypermarkets 3 13.6%
Supermarkets 2 9.1%
Department Stores 4 18.2%
Super Stores (e.g. DIY) 2 9.1%
Boutique Stores 3 13.6%
Convenient Stores 2 9.1%
Others 6 27.3%

Table 3 – Surveyed Companies Scope of Business in China

Nature of No. of
Engagement Responses %
EU Exports to China: 7 33.3%
China Production for
export to Europe 4 19.0%
China-based
production for local
market 5 23.8%
Sourcing 4 19.0%
Other 1 4.8%

The foreign companies surveyed were involved in various market segments in the distribution
sector. This is demonstrated by the diversity in the market sectors in which the companies operate.
In addition, 33.3% of the participating European companies export to China and 19% of the
surveyed import China-based products. 23.8% of the respondents are involved in China-based
production for the local market and 19% in sourcing.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 34

SECTION 2: CHINA MARKET OPPORTUNITIES

2.1 - How important is the China market for your business in terms of sales?

Chart 2 – Chinese Market Importance

67%
70%
60%
% of responses

50%
40% 34%
30% 22% 22% 22%
20%
11% 11% 11%
10%
0% 0%
0%
Today In 5 years

1 little importance 2 some importance 3 moderate importance

4 significant importance 5 utmost importance

There is agreement among the respondents that the Chinese market will become increasingly
more important to their business. Currently 56% of those surveyed considered the Chinese market
to be of significant and utmost importance in regards to their sales. The respondents percieve that
there will be a significant shift with 89% stating that the Chinese market will be of significant or
utmost importance in 5 years time.

2.2 What is the percentage of your company’s turnover in China today compared to overall/
global turnover in sales and market share?

MNCs, comprising the majority of the surveyed companies do not have a significant presence
regarding sales and market share in the Chinese market. The MNCs reported only 1-8% of their
sales are in the China market, with a number of companies reporting only 1%. In contrast, the
surveyed joint venture company is entirely reliant on the Chinese market with 100% of their sales
and market share from the Chinese market.

2.3 Over the next 5 years, how do you expect business opportunities to evolve in the retail
sector in China? How will this likely impact on your sales/ market share figures?

There is an overall consensus projecting a positive future in the Chinese market with sales and
market share figures expected to rise. Although slow, the respondents expect the Chinese market
to expand, therefore increasing demand and predicting that sales will rise by 3-5% in the next five
years.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 35

2.4 How important is China as an investment destination?

Chart 3 – China as an Investment Destination

50%
44%
% of responses 40%
33% 34% 34%

30%

20%
11% 11% 11% 11% 11%
10%
0%
0%
Today In 5 years

1 little importance 2 some importance 3 moderate importance

4 significant importance 5 utmost importance

Generally, China’s importance as an investment destination is expected to increase in 5 years

time. 45% of the respondents indicated that China as an investment destination today is of
significant and utmost importance and 33% believe China to be of moderate importance. China’s
importance is predicted to shift in 5 years time when on average China’s importance will shift from
moderate importance to significant importance. Thus 78% of the surveyed believe that China will
be of significant and utmost importance in five years time.

2.5 How much of a problem would you rate market access and other commercial practices
by China?

Chart 4 – Market Access and other Commercial Practice Problems in China 30

70%
60%
50%
% of responses

50%
40%
30% 25% 25% 25% 25%
20% 13% 12% 13% 13%
10%
0%
Today In 5 years

1 little importance 2 some importance 3 moderate importance

4 significant importance 5 utmost importance

A majority of the surveyed companies believe that market access and other commercial problems
in China will decrease in five years time. 50% of the surveyed foreign representatives reported
that problems with market access and other commercial practices in China are of moderate
importance today, but will decline over the course of the next five years (25%).

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 36

2.6 What are the main current obstacles preventing you from expanding further in the
Chinese market? Please list in terms of priority (e.g. market access constraints, IP
protection, Chinese standards/ operating practices, etc.).

Chart 5 – Main Current Market Obstacles

Number of times mentioned

25.0%

21.4%

17.9% 17.9%

10.7%

7.1%

Lack of Complex Lack of Legal Limited Supply IPR Other

Transparency in Bureaucracy and Framework Channels Infringements
Operating Government
Practices Intervention

Chinese operating practices such as a lack of transparency (25%) are considered by surveyed
companies to represent a significant obstacle to expansion in the China market. Complex
bureaucracy and government intervention, especially at the provincial level create barriers for
European companies operating in the Chinese market (17.9%). In this regard, registration
requirements for foreign invested companies are noted to be more stringent than for local
competitors. The lack of an adequate legal framework and the constantly changing product
standards by government agencies and ministries also hinders European companies (17.9%).
Limited supply channels prevent European companies from further accessing the Chinese market
(10.7%). Furthermore, the participating foreign representatives mentioned IPR infringements
(7.1%), and other obstacles (21.4%) as barriers to expansion. These included lack of financial
resources and the language barrier.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 37

2.7 How will this situation likely evolve in the next 5 years?

Chart 6 – Market Access Situation in 5 years

No Change
31%

Positive 54%

Negative 15%

There is a general positive outlook with regard to the reduction of Chinese market access
constraints (54%). Although the situation is expected to improve, it is perceived that it will do so
at a slow pace especially in the area of policy and regulation.

Table 4 – Market Access Situation in 5 years

Selected Comments

Positive “We are optimistic that the government will improve the business environment for MNCs.”
“In general we expect gradual improvement on both transparency of policies and
regulations, and their enforcement.”
No Change “Will be improved but at a very slow pace”
Negative “Chinese standards issues will likely get worse in many sectors but the legal framework
will hopefully improve.”

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 38

2.8 What are the quantitative costs or impacts resulting from these obstacles on your
business today? This can be indicated as a percentage of revenues, profits, etc. Please
specify.

Table 5 – Quantitative Costs or Impacts from Market Access Obstacles

Where respondent made estimates

Comment Sub-sector
HP SM DP SS B CS O

“20% of turnover”- Wholesale to project developers and to

●
retailers
“4-5% à When we import fixed equipment we need to pay an
import tax but if we were a local invested company we would get ●
a tax-break.” – Business to Business
“Our estimated operating costs are approx 10-15% higher than
● ●
those for local businesses”
“We got only 1% sales turnover and market share in this
market, as compared with our globally turnover.” – Oil, ●
petrochemical, and power.
“In my business the current market situation results in an extra
overhead cost of about 90% that has to be recuperated from our ● ● ● ● ● ●
customers in comparison to other markets.”
Where respondents found it difficult to quantify market access obstacles:
Comment Sub-sector
HP SM DP SS B CS O

“This will be hard to predict since it involve not only current ●

market but also potential new market.”
HP: Hypermarket
SM: Supermarket
DP: Department Store
SS: Superstore
B: Boutique store
CS: Convenience stores
O: Other

The respondents reported that as a foreign company they operate at a higher cost than Chinese
companies due to the above mentioned barriers. One respondent estimated that operation costs
are approximately 10-15% higher than those of local companies. Obstacles such as import tax, for
which Chinese companies receive tax breaks, results in of revenue constraints of 4-5%. Overhead
costs are estimated to be as high as 90%.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 39

2.9 How is this situation likely to change in the next 5 years?

Chart 7 – Quantitative Costs and Impact Situation in 5 years

No change
12.5%

Negative 25.0%

Positive 62.5%

62.5% of the surveyed companies have a positive view of their situation in the next five years. It is
believed that China’s expansion in the global market will increase the Chinese government’s
efforts to decrease obstacles preventing expansion of European companies within China. A
smaller proportion believe that in the next 5 years the situation will become negative or no change
will occur at all because the Chinese government’s actions are unpredictable.

Table 6 – Quantitative Costs and Impact Situation in 5 years

Selected Comments

Positive “We expect these costs to decrease in line with Chinese government efforts to level the
playing field. We expect and need a fair playing field in China.”
Negative “Central government will open wholesale market this year but no promise about import
market. Even for the approval of retail/wholesale project, their rule and process are
complicated and inefficient.”

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 40

2.10 How does the European distribution industry intend to maximise opportunities
brought about by the Chinese market (e.g. outsourcing/ exporting to home markets,
investment/ M&A, etc.)?

Chart 8 – Plans to Maximise Opportunities in the Chinese Market

Number of times mentioned
33.3%

25.0%

16.7% 16.7%

8.3%

Merger & Local Strategic Research & Other

Acquisition Production Alliance with Development
Local Partner

A majority of the foreign representatives stated that mergers and acquisitions can maximise their
opportunities in the Chinese market (33.3%). Establishing more retail outlets in the Chinese
market will increase their local presence, which is expected to increase profitable turnover.
Furthermore, it the use of China has been recommended as their second home market to develop
and launch new products in China. To reduce costs and optimise China’s strengths in
manufacturing, the industry representatives suggested localised global production and
development (25%). Joint ventures with Chinese companies are also highlighted to help increase
market access (16.7%).

2.11 China’s 11th 5-year programme (2006 to 2011) sets ambitious targets and priorities for
rural development, environmental protection (rural and urban), energy efficiency
(rural and urban context) as well as the need for a home grown innovation society,
affecting all sectors. This direction would represent a major step change in China’s
approach to sustainable development.

a. Please consider how the direction of China’s sustainable development as described

above provides opportunities and challenges within your own sector and business
units (e.g. new markets, new investment opportunities, partnerships, etc.)?
b. What will likely be the challenges and constraints of realising these opportunities?

The surveyed companies are optimistic about the opportunities China’s 11th 5-year programme will
bring to the sector. A majority of the respondents have already invested in several sustainable
development projects. The 5-year programme is expected to develop these invested industries
sectors, thus increasing the market size. This will then create an increase in demand for European
expertise, hence creating opportunities for European companies.

Concerns were expressed regarding the Chinese government’s commitment to the 5-year
programme and obstacles created by Chinese standard practices such as lack of transparency,
bureaucracy and corruption. Local competition operating at lower costs due to lax
implementation of environmental legislation was emphasised as being a continuing challenge to
European companies.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 41

 Table 7 – Implications of China’s 11th 5-year Programme

a) Selected Comments

New market “We see tremendous opportunities along the way, in particular from healthcare, energy
opportunities saving and better lifestyle perspectives.”
(1)
New market “Interesting development opportunities due to large demand.”
opportunities
(2)
Higher “We have already made substantial investments in R&D for alternative energies in China
standards (1) (wind energy; solar etc). We hope that the next five year plan will further support the
development of these industries and some up-front preferential treatment will be given by the
government.”
Higher “We support the FYP and believe it will raise the bar for environment protection and foreign
standards (2) investment in manufacturing as well as retail for our sector. It is also a good opportunity for
foreign investors to lead labour and environment protection for our sector.”
b) Selected Comments

Constraints (1) “Bureaucracy & transparency at local/provincial government levels; real commitment to
execute plan at local level”
Constraints (2) “Preferential treatment might not be equally endowed on foreign MNCs as on local
companies”

3.1 How significant is the competitive challenge of Chinese enterprises operating in your
sector in the Chinese market?

Chart 9 – Competitive Challenge of Chinese Enterprises Operating

in the Chinese Market 31

60%

50% 44% 44%

% of responses

40% 33% 33%

30%
22%
20%
11% 12%
10%
0% 0% 0%
0%
Today In 5 years

1 little importance 2 some importance 3 moderate importance

4 significant importance 5 utmost importance

Generally, the foreign representatives perceive that the competitive challenge of Chinese
enterprises today is of moderate and significant importance (77%) with 12% believing the
challenge to be of utmost importance. There is then a shift to 33% in the five year persoective
where the surveyed think the challenge of Chinese enterprises will be of utmost importance in 5
years.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 42

3.2 Please describe the nature of the challenge. Include the role of SOE’s in your
description. How is it evolving?

Chart 10 – Nature of Challenge of Chinese Enterprises Operating in the Chinese Market

Number of times mentioned

33.3%
26.7%

20.0% 20.0%

Upgrading of Government Lower Cost Base Other

Capabilities of Support &
Local Companies Intervention

A third of respondents, (33.3%) see the operating capabilities of Chinese companies improving,.
This presents a major challenge to European companies. Government support and intervention
(26.7%) in the industry sector will help close the technology gap between Chinese and European
companies. And with their lower cost base (20%), Chinese companies will become increasingly
more competitive. Other identified strengths (20%) include familiarity and knowledge of local
market conditions and the ability to fully concentrate on their home market without the need to
consider global operations as MNCs do.

Table 8 – Competitive Challenges from Chinese Companies

Selected Comments

Upgrading of “Chinese products achieving higher quality, good design, high technology and overseas’
Capabilities know how.”
Local Firms (1)
Upgrading of “I have seen some new projects/ aspirations of Chinese competitors which will challenge
Capabilities our current niche higher value and premium markets.”
Local Firms (2)
Lower Cost Base “Local companies can operate at lower costs than WFOEs. Once they catch up on quality
(1) and features, they will be very tough to beat.”
Lower Cost Base “SOEs are more familiar with Chinese operation practices, they can produce much cheaper
(2) product, and what’s more, they are able to grow more globally insights.”
Government “Local players in general have a lower ROI expectation, and in many cases have a lower
support & cost of capital helped by local government financially.”
Intervention (1)

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 43

3.3 What are the main advantages your company has in China compared to Chinese
competitors? Please list in terms of priority (e.g. Product/ innovation, brand, service/
maintenance, people, etc.).

Chart 11 – Main Advantages of European Companies

Number of times mentioned

23.3%
20.0%
16.7% 16.7%
13.3%
10.0%

Innovative Human Marketing & Quality & R&D and Other

Products Resources Branding Service Tech. Deve.

The surveyed companies emphasised that product innovation is the main advantage they have
over Chinese companies (23.3%). Here, it is noted that products produced by European
companies are more geared towards the consumer’s needs then those made by their Chinese
counter parts, therefore more marketable. Recruitment and retention of experienced and
well-trained staff is also believed to be advantageous in maintaining a competitive edge (20%).
16.7% of the respondents noted international brand name recognition as an advantage while
another 16.7% noted quality and services as important competitive qualities. In addition, R&D and
technological development are also stressed as advantages European companies have in the
Chinese market (13.3%). Other factors (10%) mentioned included government incentives and IPR
infringements.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 44

3.4 How significant is the competitive challenge of Chinese enterprises operating in your
sector within the US market?

Chart 12 – Significance of Chinese Companies in the US Market

80%
70%
% of responses 60%
50%
37% 37%
40%
30% 25% 25% 25% 25%
20% 13% 13%
10%
0%
Today In 5 years

1 little importance 2 some importance 3 moderate importance

4 significant importance 5 utmost importance

With regards to the competitive challenge Chinese companies present in the US market, the
respondents considered it to be of some importance to significant importance with none believing
it to be of utmost importance. The situation is predicted to change over the next 5 years where
37% of the respondents believe that the challenge presented by Chinese companies will be of
utmost importance.

3.5 Please describe the nature of this challenge. What is its likely future evolution (5yrs)?

Even though there is recognition among the respondents that Chinese product quality will improve
and will compete with European product standards in the international market, there is a
consensus that Chinese products will not pose a great challenge in the US market in 5 years time.
This conclusion is derived from the belief that the Chinese companies will not be able to
meaningfully enter the US market because of the strength that local American companies will
present in the industry sector. In addition, it is highlighted that it would be harder for China to
effectively penetrate into a Western market because they lack local knowledge and resources.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 45

3.6 How significant is the competitive challenge of Chinese enterprises operating in your
sector in the ASEAN market and other Asian markets (e.g. India, Japan, etc.)?

Chart 13 – Competitiveness of Chinese Companies in

ASEAN and other Asian Markets

80% 72% 72%

70%
% of responses

60%
50%
40%
30%
20% 14% 14% 14% 14%
10%
0%
Today In 5 years

1 little importance 2 some importance 3 moderate importance

4 significant importance 5 utmost importance

Overall, the respondents predict that China will be more competitive in 5 years time. The majority
believe that the competitiveness of Chinese companies currently operating in ASEAN and other
Asian markets to be of some importance (72%). A noticeable shift occurs when considering the
challenge in 5 years time where 14% of the respondents believe Chinese companies to be of
moderate importance today. This figure then increases to 72% when considering the situation in
five years time. Where none of the respondents considered Chinese competition in ASEAN and
other Asian markets to be of significant importance currently, 14% believe it to be of significant
importance in five years time.

3.7 Please describe the nature of this challenge. What is its likely future evolution (5yrs)?

There was a low response rate for this question. A few surveyed companies stated that China’s
challenge in their industry sector in ASEAN and other Asian countries is very low and opportunities
for further expansion are limited. It is also mentioned that Chinese companies focused on other
industry areas with the intention of entering the markets of developed countries.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 46

3.8 How significant is the competitive challenge of Chinese enterprises operating in your
sector in the global market?

Chart 14 – Significance of Chinese Firms in Global Markets

58%
60%

50% 44%
% of responses
40%

30%

20% 14% 14% 14% 14% 14% 14% 14%

10%

0%
1 2

1 little importance 2 some importance 3 moderate importance

4 significant importance 5 utmost importance

A majority of the foreign representatives believe the significance of Chinese companies today to
be of some importance (58%) with 28% reporting the challenge to be of moderate to significant
importance. In 5 years time the surveyed believe that Chinese companies will become slightly
more significant with 44% describing competition from Chinese companies to be of moderate
importance and 28% regarding it to be of significant to utmost importance.

3.9 Please describe the nature of this challenge and its likely future evolution?

There is a low response rate for this question. Of the selected responses, there is general belief
that Chinese companies do not pose a significant challenge in the future. It was mentioned that
Chinese companies are more focused in their domestic market and are now concentrating on
export oriented business geared towards OEM (i.e. US and Europe).

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 47

3.10 To what extent does the infringement on IPR affect your business with China?

Chart115 – Effect of IPR Infringement on Business with China

60%
50%
% of responses 37% 38%
40%
30% 25% 25% 25%
20% 13% 12% 12% 13%
10%
0%
0%
Today In 5 years

1 little importance 2 some importance 3 moderate importance

4 significant importance 5 utmost importance

The effects of IPR infringements are expected to decrease in five years time. 37% of the surveyed
companies stated that the effects of IPR infringements today are of moderate importance and 38%
believe it is of significant to utmost importance. In contrast, only 12% of the respondents believe
the effects of IPR infringements to be of moderate importance and 25% believing them to be of
significant and utmost importance in five years time. These figures suggest that the surveyed
companies expect more stringent laws and regulation regarding IPR.

3.11 How will this situation likely evolve in the next 5 years?

The infringement of IPR is expected to slowly decline along with improved government regulation
and enforcement. In addition, it is noted that IPR will improve along with the living standards in
China.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 48

3.12 What are the overall efforts undertaken in your industry’s field of operation to maintain
competitiveness vis-à-vis China?

Chart116 – Methods of Maintaining Competitiveness

Number of times mentioned
22.7% 22.7%

18.2%

13.6%

9.1% 9.1%

4.5%

Localisation Improve Foreign Strategic Quality & R&D/Tech. Other

& Price Mgmt & Direct Alliances Innovation Devel
Reduction Serv Investment

To maintain competitiveness within their industrial sector in China, price reduction through
localisation (22.7%), improvement in management and services (22.7%) and increase in foreign
direct investment (18..2%) were emphasised. Localisation such as hiring talented local employees
will help keep costs lower than in European companies and the company will also gain local
knowledge of the industry sector. Increase foreign direct investment is recommended in the
industry sector to illustrate their commitment to the Chinese market, thus developing relations with
the local industry and government. In order to increase market access, strategic alliances are
recommended (8.7%). Investment in continuingl innovation in all key markets and R&D/Tech.
development is vital to product competitiveness.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 49

3.13 What is your priority in dealing with the challenge posed by the emergence of China/
Chinese industry as competitors? Please list and specify (e.g. improving your
competitiveness, improving market access, seeking improvement in overall issues of
commercial transparency).

Chart117 – Priorities to Maintain Competitiveness

27.8%
Number of times mentioned

22.2% 22.2%

16.7%

11.1%

Develop Local Improve Market Access Lobby for Other

Resources Competitiveness Enforced Policy &
Regulation

Developing local resources such as outsourcing and developing local personnel to gain further
knowledge and access to the Chinese market as well as ensuring quality service and
management are keys to reducing some obstacles that are present in the Chinese market (27.8%).
Improving competitiveness (22.2%) and expanding into new markets (22.2%) are also highlighted
by the surveyed companies. Better enforcement of rules and regulations as well as increased
transparency would help eliminate some standard operating obstacles and protect European
investments (11.1%). Other methods mentioned to remain competitive are to study the Chinese
market well so there would not be wasted opportunities, improve local business development
competences and to develop good government relationships (16.7%).

3.14 Please highlight ideas for acceptable investment scenarios in China outside those
currently permitted by the Chinese government. Please be creative in considering
EU-China win-win approaches to investment and cooperation.

Among the surveyed companies there is an emphasis on the development of a “fairer market” in
China for European companies. In exchange, the surveyed companies suggest that the EU should
create a fair market for Chinese companies in Europe e.g. for textiles and shoes. In addition, the
development of an EU-China bonded warehouse zones is proposed where Chinese staff can be
employed by the European companies. This is suggested to help set working standards and
procedures in China.

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 50

 Table 9 – EU-China Win-Win Investment Scenarios

Selected Comments

“If our up-stream suppliers were encouraged to invest in China this would help our competitiveness.”
“EU program to help tier one Chinese companies to open up operations in the EU and establish stronger
presence in Europe.”
“Those big Chinese oil SOEs have had privileges/advantages in asset, network, etc. So if those assets and
networks are made as a precondition for new market/industry entry, it represents effective discrimination against
FOC which have just entered into China. So a fair play environment is important
We urge a fair market in China. Meanwhile, EU should be fair to China in some European markets. e.g.
textile/shoes. This bilateral benefit/respect and win-win solution can speed up the communication/collaboration
process.”
“EU-China bonded warehouse zones with low pricing and easy access for European companies”
“We would like to see more openness mainly in services areas, including: healthcare provisioning, financial
services, content”

EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail 51

ENDNOTES
1
Please note that only retailers with sales greater
than RMB 5 million are included in this figure.
Figures which include China’s large number of
individually owned small-scale shops (getihu) are
not available and are believed to be significantly
greater.
2
Published annually by AT Kearney
3
Figures include wholesale and retail
4
After US, Japan, UK, Germany, France and Italy,
Retail Forward, 2005 estimates
5
Speech delivered by Assistant Minister of
Commerce Huang Hai at 2006 China Retail Summit
in Shanghai
6
By sales, Emerging Markets Group, based on
Deloitte 2006 Global Powers in Retailing
7
China Statistical Yearbook 2006
8
Serves only as rough indication. Figure is for
individuals, not households, and includes both rural
and urban. Figures for 2002, Eurostat Yearbook
2005
9
As a consequence, China will soon be facing
dependency problems as the bulk of the population
enters retirement. This goes beyond the scope of the
present report, however.
10
Previously, foreign enterprises had to have an
annual turnover of at least US$ 2 billion in the 3
years prior to the application to establish a joint
venture commercial enterprise; minimum registered
capital of US$ 50 million and a minimum asset value
of US$ 200 million.
11
Amcham China and Amcham Shanghai
12
China Statistical Yearbook 2005. Available data
does not distinguish between wholesale and retail
13
UNCTAD World Investment Report 2004
14
The main reason for this is the fact that European
markets tend to be smaller than US markets, forcing
retailers to look abroad. Other considerations
include the urban geography of European cities,
which typically, due to their longer histories, have
little space for large-scale outlets.
15
Xiao Mai Bu: small-scale, family-run convenience
stores, which form an integral part of residential life
in China
16
Dobson Consulting for the European Commission,
1999
17
Thus for certain sections of the report, data will
refer to those retailers with sales exceeding RMB 5
mn.
18
The Standard, 20 March 2006
19
Calculated as the proportion of gross operating
profit of turnover. Chinese statistics use the term
“total profit”.
20
Other advantages include IP poitions and
government incentives
21
Please note that a quantification of market access
obstacles is not provided for this sector. The reason
for this is two-fold. Firstly, it generally is much more
difficult to quantify the cost of market access
obstacles for services compared to traded
commodities. This is mainly due to the absence of
key data for these sectors (esp. trade data), which is
required for any quantitative modelling. Secondly,
with comprehensive lifting of investment restrictions
on December 11, 2004 and implementation
regulations in 2005, the Chinese retail market has
recently become more open. An attempt of the
quantification of market obstacles should the reform
process stall is given under Section 6.3 of the
EU-China Trade and Investment Relations – Study 8 of 12: Distribution/ Retail
Scenarios section.
22
Books, newspapers, magazines, automobiles
(until December 11, 2006), pharmaceuticals,
pesticides, mulching film, chemical fertilizer,
processed oil, grain, vegetable oils, edible sugar, or
cotton, etc.
23
Annual Position Paper, European Chamber of
Commerce in China 2006
24
At the time of writing, Wal-Mart, the US retail
giant, is expected to announce a $1bn purchase of
Trust-Mart, China's second-largest hypermarket
chain. The acquisition of Trust-Mart will add around a
96 stores to its current 66, boosting its estimated
$1.25bn sales in China by $1.7bn. If this deal gets
regulatory approval then Wal-Mart will overtake
Carrefour as China’s largest foreign retailer.
Although Carrefour’s expansion plans are more
gradualist this will give renewed urgency for it to
fulfill its aims to open 20 stores in the country each
year, in addition to the 78 it owns already. Other
European retailers such as Tesco, who like Wal-Mart,
have recently divested operations in parts of Europe,
might also refocus on China expansion.
25
For example, China's biggest home appliance
retailer, Gome Electrical Appliances, has recently
clinched an industry-changing deal to acquire its
rival China Paradise Electronics
26
This organic growth in market share is necessary
due to foreign retailers opening up new market
segments which, until recently, were unknown in
many parts of China and which require the retailer to
offer an altogether new retailing environment.
27
The presence of Ikea would be an example of this,
where no previous Chinese competitors offering high
quality and well-priced furniture exist and there is a
gap in the market. As such Ikea has not taken away
market share from domestic but has rather opened
up an entirely new segment to the benefit to Chinese
consumers and increasing not only the presence of
foreign retailers in the Chinese market but also
increasing the Chinese retail market as a whole.
28
This estimate narrows the welfare benefits to
reform in the Chinese distribution sector and does
not take into account the wider impacts of
consumer-led growth on the Chinese economy.
29
See inter alia Treatment of the “Community
Interest” in EU Anti-Dumping Investigations,
Kommerskollegium, Swedish Board of Trade
30
These percentages have been rounded to two
significant figures.
31
These percentages have been rounded to two
significant figures.
52