The Chinese government has delivered on its promise of creating wealth for the masses, giving consumers purchasing power unimaginable even a decade ago. A recent study by McKinsey stated that the number of upper-middle class households with income between RMB 106,000 and RMB 229,000, has grown from 6% of urban household in 2010 to 14% in 2013. While the number of middle class households still outnumbers the upper-middle class, accounting for 54% of the total, McKinsey estimates that roughly 400 million citizens will be in the upper-middle class category by 2020, a CAGR of 19%. This wealth generated by the growth of China and the upper-middle class will significantly shift consumer spending patterns and market dynamics over the coming decade.
The Chinese consumer is evolving as the purchasing power of the upper-middle class grows. Upper-middle class consumers are spending on lifestyle-related aspirational products, versus just necessities. Price has become less of a factor, and consumers are no longer satisfied by cheap, low-end, generic products. Instead individuality, personal appeal and branding have become more crucial to attract and develop consumer loyalty. This migration from competition based on price to value is a new challenge for Chinese consumer businesses, emphasizing intangibles such as brand recognition, company reputation, and product quality.
Consumers from lower-tier cities deserve extra attention. Bolstered by government’s urbanization efforts, 75% of upper-middle class and affluent citizens are projected to reside in lower-tier cities by 2015. Although consumers in these cities are still in the early stage of buying premium goods, this segment is gaining sophistication with impressive speed and offers great prospects given their sheer numbers. The success of online retailers and growth in online spending in second and third tier cities demonstrates this. Buyers unable to purchase locally have begun looking for goods online. CLSA recently issued a report stating that 10% of lower-tier city consumers, compared to 5% in top-tier ones, are buying online due to the lack of physical-store presence. Shangpin, a luxury-goods e-tailer, now has about 50% of its customers from third-and fourth-tier cities. Offline channels are benefitting as well. Armani, for example, has seen sales outside mega cities lead to a profit increase of 39%.
Lunar’s portfolio is in a unique position to capture this growing consumer spending, and we have been assisting our companies to target this segment. Yonghong, for example, has launched 3 new products since our acquisition with novel packaging designs targeting newly affluent younger customers. Yeehoo has spun off Soho Baby to introduce high-end international branded baby accessories, and also worked on improvements in merchandising and their in-store experience to strengthen consumer emotional attachments with the brand. We have also seen successful sales growth for TenGuard, which innovates in appliances targeting food safety concerns. TenGuard’s machines sell for between RMB 1980 and RMB 3380, which equates to about one year’s spending on cooking oil by the average Chinese. Regardless of its hefty price tag, the company has experienced surging sales growth, with revenues up 600% this year.
We believe that we can take advantage of the opportunities and wealth generated from these emerging consumers through leveraging our control position to push management to strengthen product development, marketing, branding and merchandising. We believe our efforts will be rewarded, as a growing number of consumer conglomerates looks to capture consumer wealth by acquiring premium brands.
