For decades, thousands of small Chinese manufacturers produced average-quality goods for local consumption. And apart from a few national brands and “newly essential” consumer goods, such as TV’s, refrigerators and bicycles, little demand existed for a national consumer goods distribution network. The logic went: if you can get what you need locally, a national distribution system wasn’t necessary.

Additionally, as recently as 1985, there were virtually no urban or rural households defined as middle class. Even in 1995, households defined as poor represented more than 92 percent of urban households. So even if a sound distribution network existed, there was little demand to ship products across country. This has changed.

Fast rising Chinese disposable income has resulted in significantly stronger demand for consumer goods, as well as for components and ingredients required to produce them. As a result, within a very short period of time a need has emerged to efficiently distribute goods to more than 1,000 cities across China.

Reaching Out to Tier 1-6 Cities

Most foreign companies focus their efforts on familiar Tier 1 (largest) and Tier 2 (second largest) cities, where access and distribution is fairly sophisticated. But these 25 cities only represent 20 percent of the population and slightly more than 30 percent of Chinese gross domestic product (GDP). Reaching out to cover all cities ranked Tier 1-5 cities means having to expand a distribution network to some 330 cities that represent 27 percent of the population and 77 percent of GDP.

Getting out to the next level, Tier 6 cities, raises the count to 654 cities, 45 percent of the population and 91 percent of national GDP.

Distribution Now Seen as Critical

Today, the Chinese government views efficient distribution networks as critical to stimulating its economy and boosting domestic consumption—from the current 39 percent of GDP in China to something approaching the 79 percent in the U.S. This also is essential to improving access to inexpensive consumer goods while reducing dependence on exports for growth.

According to the Economist Intelligence Unit, aside from enormous investments in road and railways, the Chinese government recently announced plans to spend more than rmb 12 billion (US$1.75 billion) on a network of 400,000 retail stores in rural locations. To service these stores, the government has recognized the need for new distribution networks to support China’s agricultural villages that include more than 800 million people living in some 600,000 cities, towns and villages. According to the Economist, “To shore up patchy logistics in rural areas, the government also wants to grow the number of distribution centres from about 360 today to more than 1,300... If all goes according to plan, something of a virtuous circle should result.”

The Current System Is Poor

Due to subsidies for establishing rural retail and distribution centers, as well as direct subsidies to rural consumers to encourage demand, food and consumer products are expected to sell for approximately 30 percent less than in urban markets. This is anticipated to contribute to the social objective of narrowing the income gap between residents of cities and villages. The problem, however, is that the current legacy distribution system is essentially irrational, inefficient and ineffective. And massive investments in infrastructure have only begun to address these realities. Thus, the current system is a plethora of local distributors, some regional distributors, and very few, if any, truly national distributors.

Many companies that do distribute products throughout China must deal with at least three levels of distributors. The result: few companies have visibility at the store level, according to IBM Institute for Business Value. The current distribution network is so cumbersome and opaque, and collection of payments so difficult and inefficient, that companies often give up, submit to the current system, and accept cash in advance along with lack of knowledge of what occurs below national levels.

Easier Said Than Done

The way forward is to reduce reliance on relationships (guanxi) in order to get your products to market. This, however, is easier said than done, since distributors in smaller, rural markets often are the gatekeepers for purchasing decisions of many target customers, including local retail chains, government channels, restaurants and night clubs. The arrival of national chains, such as Carrefour and Wal-Mart, however, has reduced the influence of such “blockers” or “local kingpins,” at least in the retail supply chain.

Even for my firm—a leading multi-billion rmb Chinese consumer goods food company with branch offices in more than 50 cities and sales in more than 1,600—it’s never easy or simple.

Various products often have different end-user gatekeepers. Furthermore, the physical delivery systems or logistics in a given area, as well as purchasing decisions and payments, often are linked and inseparable. This further complicates matters. To make things worse, mark-ups and commissions by middle-men can be exorbitant and grossly distort the final price paid by the consumer.

Reaching Distant Cities Is Difficult

Over the last three to five years, the logistics of distribution has made great strides in transparency, reliability and service. Yet, as this has occurred, the distribution, selling, placement, merchandising and account management—outside of a few national chains who handle all aspects of sales and distribution themselves, as well as a few direct distributors and manufacturer-owned distributor networks—only typically reach the top 10-20 cities.

For my company, a Chinese distributor of wine and other imported products primarily to retailers in the top 300-400 cities, this requires building a new distribution network that focuses on sales force management, forecasting and marketing. And this system, for all practical purposes, must build on top of existing distribution networks.

The only other choice, as many have discovered, is to build your own network from scratch—a truly daunting task.

This article appeared in Impact Analysis, May-June 2009.

Matthew Rouse
About The Author Matthew Rouse
Matthew Rouse is General Manager of Shanghai Tohzen, a distributor of Gallo Wines of California and Beelgara Wines of Australia, a subsidiary of Tohkin Beverages. Both companies are linked to Totole, a Nestle invested Joint-Venture.

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