Retail Development in China’s Second-Tier Cities

College-educated Chinese workers are commanding salaries comparable with their counterparts in first world countries, while young Chinese in second-tier cities are finding themselves with a ready supply of money to spend on personal indulgences. The expendable personal income accumulated as a result of the burgeoning economy is creating a lucrative opportunity for extensive retail development in China’s second-tier cities.

Steady but Uneven Growth in the Chinese Retail Industry

China is a giant retail market, with sustained growth substantially greater than that of developed countries. With retail sales of 17 trillion RMB ($2.58 trillion) in 2011, China’s retail sales are the equivalent of over half the retail sales of the United States in 2011 ($4.7 trillion). However, whereas the United States has maximized its retail sales growth rate at 8 percent, overall retail sales in China have been steadily increasing by approximately 15 percent year over year since 2007. Relative to a worldwide average retail growth rate of 3 percent, this demonstrates that in addition to having a sizable existing retail base there is extremely strong growth in retail sales in China.

A Map Detailing the 33 Administrative Divisions of China

The 33 Administrative Divisions of China. Source: http://www.sacu.org/maps/provmap.png

Retail sales growth in China is not spread evenly across the country, but is instead highly fragmented by region. Of the country’s 33 administrative divisions (provinces, municipalities, autonomous regions, and special administrative regions), 42 percent of retail sales are concentrated in Guangdong, Shandong, Jiangsu, Zhejiang, and Henan, primarily heavily populated and industrialized eastern provinces. In contrast, China’s interior divisions such as Tibet and Gansu demonstrated the weakest retail sales over the same period.

China’s Second Tier Cities and their Growth Potential

Although capital investment and industrialization are primarily concentrated in China’s first-tier cities, second-tier cities possess the greatest opportunities for growth. Second-tier cities possess underdeveloped retail markets, and are experiencing an influx of government and corporate investment to drive faster urban development.

The City of Chongqing

The City of Chongqing, a second-tier city in China. Source: http://ph2.mofcom.gov.cn/articleimage/200706/1182018803612.jpg

Second-tier cities offer an attractive opportunity for Chinese workers to settle down. Due to the difficulties of immigrating to first-tier cities, Chinese workers are just as eager to migrate to fast-growing second-tier cities, giving companies access to a ready supply of labor and consumers. Surveys indicate second-tier cities actually offer stronger job placement prospects than larger first-tier cities, because the increased pace of urbanization and the rapid growth in the manufacturing sector translate directly into an increased demand for workers.

China’s second-tier cities possess vast retail growth potential. With an influx of new workers to second-tier cities, these workers and their families will only contribute to retail sales growth by becoming consumers in the local economy. Business Monitor International predicts that from 2009 to 2014 total retail sales in China will grow by 74 percent due to expansion into second- and third-tier cities.

The Growing Urban Middle Class

China’s middle class is growing at a staggering pace. The middle class in China is expected to increase in size from current estimates of about 200 million to 650 million by 2015, double the overall size of the United States. By 2025, 400 million more people will live in China’s cities than do currently.

Because of this rapid growth centered in second-tier cities, an exponential growth in retail capacity is necessary for China to satisfy its citizens’ demand for consumption.

Consumption Patterns in China

Across China, the most profitable retail industry sector is overwhelmingly motor vehicle sales, fuel, and auto parts, contributing to 39 percent of China’s total revenue in 2008. Food and beverage, clothing and apparel, hardware and furniture, and pharmaceutical and medical device retailers form the bulk of the remaining revenue, but face intense competition while profiting less.

The maturation of the retail market in China provides greater profit opportunities for established international brands to retail in China. Although retail as a whole is no longer an emerging market in China, the lack of established consumer preferences and high trend volatility in consumer purchasing patterns in second- and third-tier Chinese cities still bear significant similarities to emerging markets. Consumer confidence is increasing across the country, most notably in less-developed regions of the country. Increased consumer confidence leads to better brand recognition, which favors retail sales due to premium pricing and higher margins.

Expansion as a Determinant of Profitability

Due to the incredible growth projections, both in sales and volume, of the retail sector in China’s second-tier cities, investment into retail development will inevitably result in profits for the investor. With the trends of increasing urbanization, a growing middle class, and an ever-increasing pace of competition, the earlier that an investor enters the retail market in a second-tier city, the earlier they can establish their lead over subsequent entrants. By entering the market immediately, and planning to accommodate for both future growth in population and shifting consumer demands in second-tier cities, retail developers can gain a significant foothold on the retail market in China.

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