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China’s Luxury Market Grows in Lower-Tier Cities

by Neelima

July 10, 2013

Kunal Sinha, Chief Knowledge Officer and Regional Cultural Insights Director, Ogilvy & Mather Asia Pacific
Kunal Sinha, Chief Knowledge Officer and Regional Cultural Insights Director, Ogilvy & Mather Asia Pacific

Ogilvy & Mather Chief Knowledge Officer Kunal Sinha believes that China’s lower tier cities hold the key to the country’s growth

If you thought that China is all about big cities like Beijing, Shanghai and Guangzhou, think again. The next big areas of growth are lower cities in China’s interiors. With 200 million households, rising incomes and growing opportunities, China’s lower tier cities offer companies a huge, compelling and relatively untapped growth avenue.

According to AC Nielsen research, tier-one cities had a disposable income value of RMB 1 trillion, while second to fourth-tier cities had a combined disposable income value of roughly RMB 8 trillion. Kunal Sinha, Chief Knowledge Officer and Cultural Insights Director at Ogilvy & Mather Asia, has been researching this for a while now, and recently released a study titled ‘China Beyond–Change & Continuity‘, the third such study in seven years. In this interview, Sinha elaborates on the findings of this study and the implications for marketers.

(Watch the accompanying video below)

See part one of this interview here.

Q. One always associated lower-tier cities with low purchasing power, and suddenly you have consumers in the luxury market purchasing brands like Gucci and Prada. What are the income distribution patterns and wealth ownership in the lower-tiers like?

A. If you look at it in terms of just the proportion of the number of people who are wealthy in the lower-tiers, it will be small. But when you have 200 million households and aggregate that up, it can be quite a sizeable number. In fact, in the last three years (it’s just slowed down a bit this year), most major store openings have been in the second and third-tier cities. It’s perhaps a mistake to believe that people did not have the money. There are 42 million small and medium enterprises in China, and many of them are in smaller cities. It’s not that the (entrepreneurs) didn’t have the money, they just didn’t have the avenue to spend it. Now with the opening of luxury stores, they are beginning to do that. The other thing that has happened in the recent past is that the norms for traveling abroad have been eased a bit and tour operators are taking planeloads of lower-tier entrepreneurs, and flying them to outlet malls in the US or Europe. They are buying not just for themselves, but for gifting to other people, which has been part of their tradition.

Q. In the luxury market at least it seems like marketers will have to focus a little more on the lower-tiers, but generally speaking do you think we are reaching some kind of a tipping point where companies will have to reexamine their strategies in a big way?

A. We are reaching a point where it will be key to look at segmentation within the Chinese luxury shoppers. China is already the second-largest luxury market in the world, and now it’s just a matter of when it will become the world’s largest luxury market. There are more than a million US dollar millionaires in China already. The wealth not only comes from people who are entrepreneurs, but also from people who are salaried employees of very well-performing companies. It comes from inheritance in many cases. Within the luxury market there is a segment called the second-generation rich. Are you going to look at someone who is second-generation rich, who’s already had some experience of buying luxury goods and is now moving into the luxury experience market, or are you looking at the first-time buyer who is not just buying for himself or herself, but buying for a whole lot of other people for gifting? Those are the dynamics of the luxury market that the brands have started defining more clearly, and designing experiences based on these needs.

Q. Do other sectors also have to reexamine their lower-tier strategy in such minute detail?

A. Absolutely. It is clear that these markets, the consumer landscape is becoming extremely competitive. That would mean that companies will start to look for defining their strategy based on whether they are introducing their brand into the lower-tier sort of shopping basket, or are they going to take the local players head on? On the flipside, how does a local Chinese brand which is already there with significant customer engagement, react to the entry of a foreign brand to the same marketplace? Is it on the basis of having a very good understanding of the local consumer and the local culture and the local needs? Is that going to be their differentiator as opposed to the international brand positioning as an outsider? Is that the strategy that the local brand takes, or does the local brand suddenly up its offer, to suggest that they are as good, if not better, in quality, in performance, as an international brand? So those are again strategic choices that will start determining the failure of successes or successes of these brands?

Q. Is there an example of a company that approaches both the lower-tiers as well as upper-tiers well?

A. It will be hard to find examples, because by and large you find companies that have either done well in the tier one and tier-two cities, and those which are relatively better performers in tier-three and tier-four cities. When we asked respondents across the city tiers what their favorite brands were, the top three brands remained pretty much the same: Haier, Samsung and Nokia. Nokia is a surprise because people think that it’s a brand that is dead and buried. They seem to offer value-for-money and technology as a combined proposition to the consumer. But the way these brands would sell in the upper-tier city would be quite different from the way they would sell in a lower-tier city, because in the lower-tier city you have to go out to the consumer, you have to highlight the new features of the brand, whereas in the upper-tier city you perhaps want to draw them in with some news, you have to generate conversations around the brand, especially if you got something new in the new products that you have.

Q. Are there particular industries that are better poised for the lower-tier opportunities?

A. It is mostly the local Chinese companies which understand where the opportunities are. To take an example, and it is not just for the lower-tier but in general, there are local companies like this phone manufacturer which created a mobile phone just for the seniors market. The seniors are willing to spend on technology, just that they don’t want a phone that is packed with 50 features. These companies realize that what seniors want is big buttons, they want the display to be relatively big, and the phone should have voice dialing and maybe an emergency button which automatically calls a hotline or one of their sons or daughters or whoever that might be. That’s recognizing that there’s a specific need, so it’s the same way that I think consumers or certain firms back in India have discovered for example when Nokia introduces a simple thing like a torch, for truck drivers and laborers, in their phone, simply because that’s a very specific need that this variant serves. But unlike Nokia which is a multinational brand in India, the Chinese firms here tend to understand some of these specific needs very well.

The outdoor leisure market, for example: people in the lower-tier have a much closer relationship with nature and are beginning to explore their surroundings. The result is simply that you have a whole lot of local brands that are all about an outdoors experience which you will find in the marketplace, much before the established brands making a dent and start reaching out to these consumers. This is the kind of competition that they have to deal with.

Q. What about the more established Western brands? Have any of them made any impact in the smaller tier cities?

A. Nokia and Samsung are very key examples of having a range of products, some of which are targeted at lower-tier consumers: simpler and cheaper phones. But then you also have FMCG companies that allow access to a certain modern lifestyle at a very low price point. So it’s just drinking a cola, or using certain cosmetics, which are not very expensive, where they’ve been successful. Whether you look at companies like Procter and Gamble, Unilever, Coke or Pepsi, they are all making significant inroads into lower-tier markets simply because they are about a new way of life.

Q. And affordability?

A. Of course, affordability is one of the key factors.

Q. Given what we’ve seen with luxury brands and the kind of aspirations people have, do you think going forward affordability is going to be a key issue in lower tier markets?

A. I don’t think it’s just about affordability. Look at the luxury market, people are going to spend and they will want those symbols, which you know are fairly important in a social context, not just for personal experience. What is going to be a sort of key assurance point is performance. Now whether that performance is an image, dimension or is a functional thing, would depend on the product category. People want to make sure that if they have spent money, the brand of the product better do what it does, or what it’s promised to do. So that will be one of the things the brand will have to start demonstrating increasingly. It’s through that performance that they will be able to really build trust amongst consumers.

Companies like Adidas realized that if they want to do well in China they have to reach out to lower-tier consumers. And they got to reach out through distribution, they have to reach out through nicely designed products that are not priced very, very high. They are beginning to make a dent in that market, and the reason I bring performance into this is because most young people associate sportswear brands with youth fashion rather than performance, but you add on the performance dimension to it, and that gives the brand an extra kick really both figuratively and metaphorically.

Q. Let’s juxtapose Adidas with a domestic brand like, say, Li-ning? Li-ning is now consciously reducing its focus on the lower tier cities. Is that because they didn’t crack that market very well, or it was just a conscious decision not to focus on the extreme lower tiers?

A. No, I think Li-ning is just an example of many Chinese brands which want to become more international and start appealing to fashion-consciousness and some of those values, than pure performance or pure value-for-money. When you do that, you might lose out on a customer base, and that’s a strategic choice that the brand makes. They have now decided to refocus the brand to a segment which is going to be the future, and it’s really how successfully they’re able to execute the strategy that will determine the fate of the brand. It would be really interesting to see how the market expansion strategy for Adidas really works out in the next couple of years, and how the plan for Li-ning to become a bit more international plays out.

Q. It’s actually interesting: it seems like the local Chinese brands want to trade up, and the MNC brands want to go some notches down.

A. That’s what’s creating intense competition in the marketplace, because they are really seeing the future growth opportunity in each other’s strongholds. That creates this situation wherein the growth in advertising spend outpaces the sort of general spending in the economy by several times.

Q. Can you encapsulate some of the implications of your latest research?

A. That’s a hard one because implications would vary from product category to product category, from city tier to city tier. They are multifaceted. It’s about recognizing that bringing the consumer in early is very important. Do not underestimate the potential and the ability to adapt to change as far as the lower-tier consumer is concerned. They are not resisting change, they are embracing it perhaps faster than companies are embracing change. So if you thought that you should be listening to only the leading-edge consumer in the big city, the trendsetter so to speak, that’s no longer the case. You got to keep your ears firmly to the ground even in the smaller towns, because the bigger growth opportunities are there.

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